SOUTHEAST EUROPE AND THE WORLD WE LIVE IN

DANIEL DAIANU

SOUTHEAST EUROPE
AND THE WORLD WE LIVE IN

EDITURA ACADEMIEI ROMNE

BUCURETI, 2008

Copyright The Romanian Diplomatic Institute, 2008.

All rights reserved.

Descrierea CIP a Bibliotecii Naionale a Romniei

DIANU, DANIEL
Southeast Europe and the world we live in /Daniel
Dianu. Bucureti: Editura Academiei Romne, 2008
ISBN 978-973-27-1628-1
821.135.1-92=111
070(73) Southeast EuropeTimes (0:82-92) 2002/2007

Editor: Rodica FLORESCU

Computer Operator: Luiza DOBRIN
Cover: Nicoleta NEGRU
Final proof: 28.01.2008. Format: 16/54 84
D.L.C. for large libraries: 330.191.6(4)(081)
D.L.C. for small libraries: 33

CONTENTS
Foreword by Armando Marques Guedes ........................................
Preface by Franz Lothar Altmann ...................................................

7
9

Introduction ...................................................................................

13

Part I: The world we live in ..........................................................

17

Events spur re-examination of business ethics, social

responsibility...........................................................................
Which globalization is the way? ........................................
Is unconventional economics staging a comeback?..............
Will developmental economics stage a comeback? ............
Economic policy: the end of ideology?..............................
Who fears outsourcing and off-shoring?............................
Oil prices, emerging economies reshape global picture..............
The race for competitiveness .............................................
Why fast economic growth isnt enough ...........................
The soul of capitalism........................................................
Part II: Which way goes the European Union ............................
The EUs biggest challenge: managing rising complexity.....
Is the European model sustainable....................................
Agriculture and the Doha trade round ..............................
States must balance tax competition in Europe ................
Maintaining low inflation in transition economies ...........
EU referenda complicate accession prospects ..................
Cooperation, compromise are backbone of EU
enlargement ................................................................
Lessons of EU accession ..................................................
Economic patriotism in the EU .....................................
Labor markets and effects of migration ............................

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22
26
30
33
37
41
44
48
51
57
59
62
65
69
72
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79
82
86
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Part III: Romanias journey to the EU ........................................

95

Economic policy focus: tax revenues in Romania...........

97

Romania, the IMF and an expected decision...................

Rushing into the capital accounts is risky........................
Does Romania have a functioning market economy?......
EU accession roadmaps could cause some bumps ..........
Romanias economic policy challenges in 2004..............
For Romania and Bulgaria absorption capacity is
essential.....................................................................
Revenues and the flat tax in light of Romanias EU
accession..........................................................................
Romania and the Lisbon Agenda.....................................
The Romanian economy: what to watch for in 2006 .......
News mostly good for the Romanian economy...............
Euro adoption is to be approached carefully ...................
Part IV: The Balkans and the EU ................................................
Economic reconstruction: the role of European Aid........
Unemployment in the Balkans: how much of a concern? ....
Will economic recovery last in the Balkans?...................
Infrastructure is key to economic development and
cooperation ......................................................................
The Latin American crisis: lessons for the Balkans.........
Tax policy in Southeast Europe: some issues..................
Absorption capacity of EU funds plays critical role for
membership seeking countries ..................................
Conflicting perceptions and economic challenges...........
Positive signs of cooperation...........................................
EU constitutional disputes and Southeast Europe ...........
EU enlargement and the Western Balkans ......................
World Bank forum targets growth in Southeast Europe ..
NATO membership: what it means for economic
development ....................................................................
Fighting corruption in SEE countries: the EU factor.......
EU Presidency holder Austria has close ties to SEE
countries....................................................................
Which way ahead for the Western Balkans? ...................
Economic, political, and institutional adjustments needed
for countries joining the EU .......................................
References .......................................................................................

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FOREWORD
It is rare that the scope of books written by economists
ranges beyond the technicalities of their often very specialized
subject-matter. In this one, however, it certainly does and in a
manner which is most welcome. It fills a gap. Professor Daniel
Daianu is not only a researcher internationally recognized for his
academic excellence; he is also, as a former Minister of Finance
and a high level advisor, a seasoned practitioner. In this collection
of newspaper articles published in the Southeast European Times
a collection now for the first time aggregated in one volume
Dr. Daianu manages with ease, depth, readability, and intellectual
panache to go well beyond the usual limits which afflict specialists.
Here is a set of papers that throw a bright light both on the
political background and consequences of a thickening mesh of
economic and political interdependence in a Southeastern Europe
which was for far too long led astray from the central role that it
can and should and surely will fulfill in the process of regional
cohesion, an unfolding project that simultaneously marches toward
global integration, and does so while guaranteeing a careful
balance between human dignity and rising standards of life.
Professor Daianu is the paladin of an erudite version of that
project. Carrying it out will not be an easy task in an Eastern
Mediterranean that has been in a less complex neighborhood.
Mapping issues, and touching upon the ongoing successful
experiences of Romania and Bulgaria, Daniel Daianu craftly
designs paths to guide his part of our common world, in a manner
which is both democratically and economically enriching, towards
an achievement of these results. This is economics that is, choice
at its best.
Armando Marques Guedes
Professor, Faculty of Law of the Universidade Nova de Lisboa, Portugal
President of the Portuguese Instituto Diplomtico

PREFACE

Which world do we live in? This is an appropriate

question heading the first part of a collection of articles
Daniel Daianu had written and published over the past
extremely exciting years that have changed Southeast Europe
and the World immensely. Not everything developed as
rapidly positive as expected or hoped, and many appearances
call in fact for interpretation and/or justification. How do we
see for example globalisation and neo-liberalism in the
context of the transformation efforts of the countries in
Central East and Southeast Europe? Is free trade equally
beneficial for all economies regardless of their level of
development and competitiveness? Often we feel as if certain
issues do have more than two sides of a coin, and this is what
Daianu is trying to make us aware of. The world we live in is
changing every day, and so do economies as well as politics,
becoming more complex and also much more detailed at the
same time. It is not surprising that socio-economic theories
have problems to follow and explain the trends and new
phenomena. Daianu calls it the search for the ultimate piece
of wisdom, the ideal type of economic policy whereby
ideology is not dead as he describes it convincingly in his
piece Economic Policy: The End of Ideology? No, on the
contrary, we discuss Keynesianism and monetarism,
neo-liberalism and laissez-faire, globalization versus global
capitalism, free trade versus fair trade, welfare economics
versus deregulation, flat tax versus socially adjusted tax rates
and so forth.
8

In fact, we live in a world of increasing varieties and

challenges where answers to many of the worrying questions
are often difficult to formulate since economic theory and
social approaches may collide with reality in politics and
economics. As an example financial liberalisation may serve
which started in the late sixties and early seventies becoming
one of the most important processes in the world economy
over the last two decades of the twentieth century. It
influenced positively the level of interest rates and indirectly
the structure of capital costs, the marginal efficiency of
investment and the levels of aggregate savings. But it is
rather puzzling that over the last two decades of the twentieth
century four out of ten fastest growing economies were
largely or partly financially repressed: South Korea, Taiwan,
Sri Lanka and in particular China.
Reading Daianus articles we find this variety of issues
and questions addressed, and to a great extent also answered
respectively explained from a viewpoint that is European and
Southeast European at the same time. The challenges are not
always of global nature, many are special for Europe and
even more special for Southeast Europe. Which way goes the
European Union is he asking, and the answer is definitely not
given. A success story as it undoubtedly is, the EU today is
torn between deepening and enlargement facing growing
scepticism if not even disaffirmation regarding the latter in
the core (old) member states. The constitution issue depicts
most visibly the different views whereby some of the New
Europe countries from the 2004 enlargement seem to fall
after their accession into political populism and disarray and
a kind of national thinking and economic patriotism which
irritates Old Europe To be fair, also in the latter we
observe an apparent resurgence of protectionism. Daianu
explains this by arguing that liberalism (or globalisation), by
its very nature, brings about such reactions throughout the
world, in rich economies as well as in poor ones.

10

But apart from economics, do we see progress in

developing other areas of cooperation, like e.g., in Common
Foreign and Security Policy? We should not be too quick in
answering NO, because there are many areas where the EU
member countries have been able to find the necessary
compromises and willingness to cooperate. But even if CSFP
is still more a project than reality, it cannot be neglected that
the EU has become an important international player, more
often as a mediator than as actor, but nevertheless respected
as a growing soft power with balanced interests and
approaches in international conflict resolutions.
The European Community did not have aspirations for a
common foreign policy before the wars in the Balkans erupted
in the early nineties. The need to speak with one voice became
obvious after the shaming disunity over whether and how to
intervene in order to stop killing and looting. Since the mid
nineties the European Union (EU) became more and more
engaged in Southeast European issues after having been on the
military level only junior partner of the USA in the early years
of the Balkan conflicts. However, starting in the late nineties
the European Union is increasingly taking over also
commitments in the military sector and in particular in the
larger security sector areas. However, for the sustainable
stabilization and development of the Balkans the offer of the
European Union of a membership perspective for the Western
Balkans, given at the Thessalonica summit in 2003, is much
more important. But it is not only for the sake of the Balkans
that the EU perspective is kept alive, also for the EU itself the
white spot which the Western Balkan countries now represent
by being completely surrounded by EU member countries
shows how incomplete the European reunification still is. The
world we live in needs a strong and stable Europe, and Europe
will not be stable and free from internal disruptions, clashes
and conflicts as long as parts of Southeast Europe are
separated from the process of European integration.
11

The collection of articles presented in the book at hand

does not only induct the reader into the most relevant and
topical issues of contemporary importance if one deals with
Southeast European affairs, but in addition offers many
inspiring reflections and approaches which go beyond the
ordinary and traditional way of arguing. It mirrors in an
impressive manner the rather rare combination of academic
analytical (economic) thinking and practical political
reviewing and evaluation which is needed to understand the
complexity of the difficult situation of disrupted Southeast
Europe. Daianu as an economist by profession and an
internationally well reputed former finance minister proves
this ability convincingly.
Dr. Franz-Lothar Altmann
Associate Professor, German Institute
for International and Security Affairs (SWP), Berlin

12

INTRODUCTION

Southeast Europe, when seen as a cluster of countries,

has gone a long way toward establishing the institutional
underpinnings of market economy while political pluralism
has become an entrenched fact of life. Bulgaria and Romania
have joined the European Union at the start of 2007, which
should provide more ground for optimism regarding the
region as a whole. Economic recovery has been a constant
feature in recent years, inflation is quite low region-wide,
and financial systems are much more solid than a decade
ago. Nonetheless, major economic problems (such as huge
unemployment, extensive underground economies and aid
addiction) persist and institutional weaknesses are highly
visible.
A big question is what type(s) of capitalism(s) will
evolve in the Region. Institutional fragility as experience
elsewhere in the world amply shows is not easy to deal
with, the functioning of state bodies is fraught with conflicts
of interest against the backdrop of widespread corruption,
income inequality has been rising sharply, and citizens
bitterness shows up at the polls, sometimes, in a disturbing
manner. In addition the political geography of the Region
is still blurred the status of Kosovo being the most glaring
case. These circumstances indicate that, though progress has
been considerable according to a democratic agenda during
the past 15 years, still much lies ahead so that the citizens of
Southeast Europe feel the benefits of economic reforms and
political liberties comfortably and securely.
13

I have been a regular contributor to Southeast

European Times (formerly Balkan Times) for several years
now. In my articles I have tried to present views on various
policy issues, which have come out from my experience as a
Romanian policy-maker and as a concerned observer of the
economic and politics of this region. This volume brings
these articles together. I have tried to look at problems
afflicting the Region from a wider, European, perspective,
which itself is embedded into a global framework that
regards demographic dynamics, institutional vibrancy but
also fatigue, trade frictions, and not least, the economic rise
of Asia.
The first part takes a look at a series of global issues
which have a bearing on Southeast European countries as
well. The second part examines how the European Union has
been evolving in the past decade, the challenge of managing its
growing complexity and dealing with unfavorable
demographics, the impact of the global race for
competitiveness. Part three refers to Romanias journey to
the European Union and part four looks at the Balkanss
quest to join the European Union. At the end of the volume
there are references to authors whose work is mentioned in
the articles.
A silver-line of my articles is that the whole of
Southeast Europe should join the European Union; the
sooner the better.

Dr. Marta Muco, whom I had known for years as a keen observer of
economic developments in the Balkans, whether I would like to write for
Balkan Times (currently Southeast European Times/SETIMES).
I accepted and this decision was the start of five years of collaboration.
I used this opportunity to write monthly columns in SETIMES where
I shared thoughts on various economic and political issues that concern
Southeast Europe and, in a wider context, Europe as a whole. Over time
I realized that the range of topics I have dealt with provides the skeleton
and the flesh for a structured way of looking at Southeast Europe, for
examining the broader picture. When the Romanian Diplomatic Institute
(RDI) invited me to come up with a personal contribution to a new series
of publications I seized the chance to bring all these pieces together.
Professor Vlad Nistor, the General Director of the Institute, and Dr. Radu
Dudau, the Director of Research of the RDI, have made it possible and
I am grateful to them for their encouragement and support. I also thank
Ms. Alina Bacanu for the kind assistance in preparing the manuscript for
publication. SETIMES is thanked for the permission to reproduce the
articles which I wrote during 2002-2007. The name of this volume might
strike a resemblance note with Will Huttons The World WeRe In; this
was not intended.

Daniel Daianu

Acknowledgements. I should start with what lies at the very origin of this
collection of articles. After my stint as a high public servant in the
Romanian Government (1997-1998) I was invited to teach in the USA,
first at Berkeley, and next, at the UCLA. While being there I was asked by

14

15

PART I
THE WORLD WE LIVE IN

EVENTS SPUR RE-EXAMINATION

OF BUSINESS ETHICS, SOCIAL
RESPONSIBILITY

Adam Smith is regarded as the father of economics,

mainly for his book The Wealth of Nations. But he also wrote
The Theory of Moral Sentiments, which underlines the moral
underpinnings of a vibrant and socially cohesive capitalism.
Smith's vision, in turn, can be linked to Max Weber's famous
work, Protestant Ethics and Capitalism, which further
explores the tie between values, institutions and economic
performance. Francis Fukuyama, in "The End of History"
was right in a fundamental sense the demise of totalitarian
communism closed a chapter of history. But many of his
hopes have been clouded by events during the last decade.
Lately, issues of business ethics and social
responsibility among firms and individuals have been at the
forefront of public debate. Widespread corruption and
unethical behavior are primarily seen as features of
institutional fragility and a lack of democratic credentials,
found in the developing world in particular. But the recent
spate of corporate scandals across the Atlantic and in Europe
illustrate a more complex reality. A similar wave of scandals
gripped the United States in the 1980s. Is there a cyclical
pattern in advanced economies, linked with unavoidable
behavioural excesses during periods of exuberance, which
then subside over time following policy and institutional
adjustments? Or, can one establish institutional
circumstances and peculiar policies which enhance unethical
19

behavior, and which do not trigger adequate responses

automatically? Can one link the social and economic
dynamics of capitalism to apparent shifts in the values that
drive entrepreneurs' behaviour? Is the profit motive
equivalent to greed or, to quote Alan Greenspan, "irrational
exuberance"? What is the role of norms (formal and
informal) in constraining socially irresponsible behavior?
The post-communist transition is replete with cases of
corruption and unethical behaviour. The simple explanation
points to the institutional weakness of post-communist
societies, a precarious functioning of checks and balances
and a corrupted judiciary together with a feeble law
enforcement capacity. In an optimistic vein, the same
reasoning would highlight the advance of structural and
institutional reforms, which allow these societies to reduce
malign and unethical behaviour over time. Joining the EU
can be viewed according to this upbeat logic. A more
broadly defined answer, however, would look at the issue of
governance in both the public and the private spheres and
scrutinise lessons worldwide, both in rich and poor countries.
Alternatively, a pessimistic answer would talk about a "path
dependency" and note the persistence of widespread
corruption, precarious institutions and malfunctioning
markets in large parts of the world. In Southeast Europe, the
weak state syndrome and the fragility of institutions, as well as
the widespread criminalisation of economic life, should be
causes for deep concern.
In transition societies, the prospects of joining the EU
have operated as a catalyst for reform and a strong support
for dealing with the pains and frustrations of social change.
But more than a few citizens are disappointed by the results
of reforms, while widespread corruption and unethical
behaviour anger much of the population. Some citizens relate
these phenomena to market reforms, and this perception is
20

reflected in the polls. Once the first wave of accession takes

place, benefits would accrue to many citizens, but
disappointments, too, are likely to become more intense.
Such likely outcomes call for a candid discussion about the
linkage between values, morality and the dynamic of
capitalism, and about what is needed to make it more
fulfilling for most of the population. This is why the public
debate on effective regulations, enforcement and institutions
which should strengthen the ability of markets to deliver
consumer satisfaction and prevent massive social exclusion
has not lost any relevance. The scope of the state in
providing public goods should be judged in the same vein,
although this role should be judged in conjunction with the
need for a streamlined and more efficient public sector,
which should not undermine the proficiency of the private
sector.
The public debate on ethics and the economy acquires
new overtones when looking at the world in light of
globalisation. Aside from transnational terrorism, one can
point to the dark side of globalisation: inability to cope with
global and environmental issues, massive illegal
immigration, increasing poverty in many areas of the world
and poor functioning of international financial markets. In
this context, issues of governance acquire more salience.
And governance cannot be dissociated from the values and
mindsets of those who make decisions.
The years following the Great Depression brought
about new regulations, aimed at restraining excesses and
unethical behaviour. An example was the Glass-Steagal Act
in the United States, which separated investment banking
from commercial banking. Recent scandals in the corporate
world call into question the wisdom of the wide deregulation
that occurred in the banking industry and in energy markets
in the late 90s. Institutional adjustments followed the end of
21

the Second World War as well. History seems to indicate a

cycle of policies and institutional adjustments following
large economic dynamics. It may be that after the
"deregulation euphoria" which featured so highly on the
agenda of governments, a new phase is about to set in. This
phase would underline the need for effective market
regulations and a more enlightened co-operation between the
public and the private sphere.
This logic would have to apply to the international
economy as well, which needs public goods and demands
reshaped international institutions capable of ensuring global
governance. These challenges cannot be dealt with unless
economic rationality blends with social and moral values.
The lessons are particularly valid in transition societies,
where the issues of governance and social responsibility in
both the public and private spheres are very acute.
.Setimes 23.12.2002

WHICH GLOBALISATION IS THE WAY?

There can hardly be a concept in international life that
has triggered more controversy in recent years than
globalisation. Some, particularly in the rich countries, see it
as a deus ex machina for doing away with misery and
conflict in the world. Others, especially in the poor countries,
see it at the roots of mounting tensions in the world. Why is
it so? What lies behind this stark cognitive dissonance?
There are two ways of looking at the dispute: one is to
scrutinise facts which, directly or indirectly, rightly or
wrongly, are related to globalisation; another is to examine
the concept itself, its very content.
22

Facts give highly conflicting signals. Technological

change has reduced transportation and transaction
(information) costs and speeded up the transfer of knowhow, albeit in a highly skewed manner, among regions of the
world; the internet connects hundreds of millions of people
instantaneously; world trade has expanded tremendously and
broadened the scope of choice for individuals throughout the
world. The collapse of communism has expanded the work
of market forces and democracy in a large area of the world.
And the very dynamic of the EU can be seen as an alter ego
of globalisation on a regional scale. At the same time, the
distribution of wealth in the world seems to be more unequal
nowadays than 20 years ago; the myth of the "new economy"
has dissipated and corporate scandals in the affluent world
show that cronyism and bad governance are a more complex
phenomenon than is usually assumed and ascribed
geographically; financial and currency crises have been
recurrent in emerging markets and have produced economic
and social havoc in not a few countries; trade liberalisation
has primarily favoured rich countries, which preach what
they do not practice; social fragmentation and exclusion have
been rising both in rich and in poor countries; there is a sense
of disorder and a rising tide of discontent and frustration in
many parts of the world; nonconventional threats, the use of
mass destruction in particular, are looming menacingly.
Arguably, to make sense of the facts is to look at the
conceptual underpinnings of globalisation. And here there is
an interpretation of globalisation which is pretty much
overloaded ideologically. Let's be more explicit. The last
couple of decades have clearly been dominated by a
paradigm, one which has extolled the virtues of unbridled
markets, privatisation and extreme downsizing of the public
sector (state intervention in the economy); this philosophy
has widened to international markets finance and trade
23

and the IFIs have often championed it. The way the IMF
pushed emerging countries into opening their capital
accounts during the 90s is a glamorous illustration of this
approach. Another example is the way energy markets were
"liberalised" in emerging economies without proper
regulations, which should protect consumers. This paradigm
has retreated somewhat in recent years, following
disappointing economic performances around the world and
the nefarious functioning of financial markets. But its
resilience is powerful and visible even in how it shapes the
language used by the media.
Globalisation can be understood in a different vein,
which looks at the functioning of real markets - with their
pros and cons and which takes into account insights of
advanced economic theory such as informational
asymmetries, increasing returns (while technological
progress is intense), agglomeration effects (clusters),
multiple (bad) equilibria, the role of economic geography,
and so on. The salient lessons are obvious: the need for
effective regulation of markets; the role of the state in
providing public goods; the role of institutions (structures of
governance); the need of public goods and good governance
in the world economy; the importance of variety and policy
ownership in policy-making. To some, this interpretation
may sow seeds of confusion. But, in this way, one can dispel
a biased interpretation of globalisation. Moreover,
globalisation would no longer be assigned an ideological
mantra and one-sided policy implications. Instead, it
becomes an open-ended concept, which purports to define
the mutual "opening" of societies, under the impetus of
technological change and the manifold quest for economic
progress. Moreover, it rids itself of a perceived Westcentered origin. Such an unconstrained interpretation of
globalisation would have major repercussions for national
public policies and international politics.
24

Thus, national public policies could be fairly pragmatic

and varied (not succumbing to fundamentalism) and geared
towards the traditional goals of economic growth, price
stability and social justice. Markets would have to be
properly regulated and the state would have to provide
essential public goods, which crowd in private output. As the
rigged financial and energy markets in the United States
have shown, these concerns are valid for rich and poor
countries alike. Dani Rodrik, the well-known Harvard
University academic, aptly observed that there is no modern
economy that does not blend the public and the private
spheres. An inference would be that going to the extreme
with privatisation could be more than deleterious, which is
particularly valid in the case of public utilities.
The international economy is replete with problems
that need adequate answers. Financial markets under the
pressure of volatile capital flows function precariously, and
the system needs revision. It appears that one of Keynes'
intellectual legacies, enshrined in the Bretton Woods
arrangements (namely, that highly volatile capital flows are
inimical to trade and prosperity), has not lost relevance.
Those who say that it is hard to fetter capital movements in
our times make a strong point, but do not solve the issue. The
volatility of financial flows imparts a deflationary bias to
policies worldwide, enhances trade protectionism and
competitive exchange rate devaluations. Ultimately, the
international financial system would have to undergo
substantive changes in order to avert lethal crises.
Free trade cannot benefit poor countries when rich
economies heavily subsidise agriculture and use trade
barriers whenever they feel "injured"; double talk and
hypocrisy make a mockery of the virtues of free trade and
give moral ammunition to advocates of fair trade. Likewise,
diminishing aid to very poor countries is hard to justify when
25

acknowledging the huge asymmetries in the world. A keen

sense of urgency and pragmatic vision would demand a
different policy in order to deal with the threats of spreading
epidemics, massive illegal migration, abject poverty and
environmental disasters not to mention the scourge of
international terrorism. All these challenges make up an
agenda which can be assumed by an enlightened
interpretation of globalisation.
It was refreshing to listen to Tony Blair's expose in
front of the British ambassadors recently. It was heartening
to see that a leading Western statesman understands there is a
need to listen to the rest of the world, to the voices of the
disenfranchised; that unilateralism and narrowly defined
interests cannot work in a "global society"; that the values of
liberty, decency and morality cannot be divorced from a
sense of trying to achieve more justice worldwide. To sum
up: the war against terror needs a much broader agenda and
an enlightened interpretation of globalisation would help to
this end.
Setimes 17.02.2003

IS "UNCONVENTIONAL" ECONOMICS
STAGING A COMEBACK?
For a keen observer of macroeconomic policy
dynamics worldwide, a sequence of developments provides
much room for reflection. Let's consider facts. Interest rates
in the United States have reached the lowest level in almost
40 years, with the federal rate reaching 1.25 per cent lately.
The justification for this sharp decline (from the level of a
couple of years ago) is the need to avoid a prolonged
26

recession after the burst of the stock market "bubble" and the
demise of the so-called "new economy". Otherwise said,
monetary policy is seen as a weapon for preventing
aggregate demand from falling too much. Moreover, a
member of the Federal Reserve System board, Ben
Bernanke, made a stunning statement a while ago: against
the narrowing down room of maneuver, following the very
low level of interest rates, the Federal Reserve System would
be ready to intervene to buy US Treasuries as a means of
injecting liquidity into the economy. In IMF terminology this
would be money printing strongly discouraged by IFIs
throughout the world in order to combat inflation.
In Japan, where deflation has gripped the economy and
interest rates have decreased to practically zero for years
now, some reason along similar lines. They envisage
defeating what Keynes, probably the most influential
economist of the 20th century, called the liquidity trap; they
contemplate the Bank of Japan resorting to inflation-creation
via money printing by buying government bonds as a
means of reviving consumption and thereby steering the
economy out of its long stagnation. The European Central
Bank, too, seems to be giving up its ultra-orthodox stance
and cautiousness regarding the persistent sluggishness of the
European economy. Recently, the ECB cut its key rate to 2.5
per cent; other cuts are expected this year.
The rate cut of the ECB has occurred at a time when
the strictures of the Financial Stability Pact are taking a
severe toll on some of the largest European economies,
which can hardly cope with the 3 per cent budget deficit
limit. Consequently, there is some talk of reviewing and
possibly adapting the Pact to the reality of slow economic
motion in the EU. One can detect here the attempt to
combine a more relaxed monetary policy with a budget
stimulus for the sake of stimulating economic activity. This,
basically, is the logic of Keynesian economics, which says
27

that governments have a role to play in macro-economic

management through policy tools: monetary exchange rate
and budget policy.
Meanwhile, the Bush Administration has announced a
budget for this year and estimates for 2004. These are
reminiscent of the Reagan years, a time when budget deficits
ballooned. As a matter of fact, a heavy dose of Keynesian
economics can be seen in this budget, although one can
harbor serious qualms about its fine print and sustainability.
The IMF has backed down from its push for capital account
opening worldwide, in the aftermath of financial and
currency crises. Exchange rate competitive devaluations are
also being attempted around the world, and trade disputes are
coming increasingly into the limelight. Interestingly, bailouts
have taken place in some industries (both in the United
States and in EU member countries) when national security
considerations seem to have gotten the upper hand.
There are several ways to interpret the policy
developments mentioned above, which are quite surprising in
view of the dominant paradigm of the last two decades. This
(neo-liberal) paradigm extolled the virtues of low budget
deficits (balanced budgets), low inflation, no interference of
government in managing the economy, full privatisation and
so on. I would note, first, that inflation is at a very low level
in both the United States and in Europe, a fact that annuls
much of the fear of using inappropriate monetary policy
counter-cyclically. Secondly, balanced budgets should be
examined over the cycle, which may give governments some
leeway in tolerating temporary higher deficits. It is true,
however, that the sustainability of budget deficits should be
of concern; it is good that debate is taking place in both the
United States and in EU member countries. Last but not
least, paradigmatic fundamentalism seems to be on the
retreat; people, both in policy-making circles and in
academia, realise that intellectual bigotry is not of much help
28

in the real world, that market economies need effective

regulations (a fact which was amply proved by financial,
energy markets and corporate scandals), that governments
have a role to play in economic life when it comes to
providing public goods including effective regulations.
This would be the rationale for the comeback of policy
measures which some would view as "unconventional".
These measures, on the one hand, do not mean giving up the
ABC of sound economics; on the other hand, they connote
the need for policy to vary, according to circumstances.
How should this return of "unconventional" economics
be interpreted in transition economies? Clearly, where
inflation is still high, implementing lax monetary policy
would be counterproductive; inflation would creep up again
and bring about instability. Likewise, where quasi-fiscal
deficits are high and financial discipline is low, higher
budget deficits would strain credit markets and maintain high
interest rates, crippling firms. Exchange rate depreciation
would also stimulate inflation wherever macroeconomic
stability is fragile and inflationary expectations are not
favorable. The bottom line is: transition economies need
solid institutions and a good economic performance track
record in order to experiment, relatively safely, with
"unconventional" policy measures. But some flexibility and
autonomy of macroeconomic policy is quite useful in order
to deal with powerful adverse shocks. If macroeconomic
conditions do not provide much room for macroeconomic
policy variation, other instruments can be used more flexibly.
I am referring to trade policy, which needs to be more in tune
with the reality of asymmetries in the world economy.
Frequently, what is preached by powerful economies is not
practiced; the opening of the capital account should be
undertaken with prudence, and only when institutions are
solid and the economy is more or less stable; privatisation
should go hand in hand with effective measures of enforcing
29

competition. In case public utilities are privatised (whether

totally or partially), these operations should not be done
blindly, without regard to the prices end users would have to
pay, for governments have a moral and fiduciary obligation
to preserve wide access to public goods for their citizens.
Setimes 7.04.2003

WILL DEVELOPMENTAL ECONOMICS

STAGE A COMEBACK?
The basic rules of the economic game which underlie
the sound functioning of economies can hardly be
questioned. Free prices and competition are essential for
proper resource allocation; there is a need for clearly defined
and protected property rights in order to foster
entrepreneurship and commercial transactions; hard budget
constraints need to operate ubiquitously in order to have
financial stability; over the longer term low budget deficits
are better than large ones; money printing is bad for
monetary stability. At the same time, however, intellectual
bigotry and doctrinal fundamentalism are detrimental to
good policymaking, which needs to be pragmatic and not
skewed towards vested interests.
With a new millenium now under way, the jury is still
out on several central issues which have divided economists
over the decades. This ambiguity should trigger a more
candid debate among policymakers and government
advisers. Let me single out some of the central issues which
concern the situation of the developing world, in particular:
Although free trade is deemed desirable by most
economists, the existence of large asymmetries and dynamic
30

effects provide a rationale for developing countries to seek

some protection; some distinguish between free and fair
trade. As Dani Rodrik put it, free trade is not always
conducive to economic growth. The failure of the recent
trade talks in Cancun is a stark reminder of this reality,
which relates to the discrepancy between what rich countries
preach and what they practice (the case of agriculture
subsidies is notorious).
Free capital flows have been revealed to be quite
threatening for emerging markets. The IMF no longer
recommends the opening of the capital account, as it used to
a decade ago, unless proper regulatory and institutional
prerequisites exist.
There is renewed interest in market co-ordination
failures and an acknowledgment that a rationale exists for
public intervention in the economy in this respect. The
proliferation of financial and currency crises, as well as gross
irregularities in the functioning of other markets (energy
trading, for example), make a compelling case for
strengthening regulatory frameworks and law enforcement
by the state (some would say that a "market-oriented
regulatory state" gets an increasing profile).
The role of government in providing public goods is
undeniable. In addition, some would argue that fostering
industrial and technological development is also part of the
government's role. The EU's Eureka programme, as well as a
series of defence programmes in the United States, can be
described as examples of industrial policy.
Fiscal neutralism, if taken to the extreme, can be
deceptive in a world of large asymmetries. There are
numerous examples of advanced and emerging economies
which use fiscal devices cleverly, in order to promote
national economic goals; such devices can be used in order
to foster domestic savings.
31

Who is accountable for the provision of public goods

in the world economy? Do major economies have a moral
and operational responsibility in this respect, including the
co-ordination of various policies in order to avert bad
equilibria in the world economy?
While underscoring the pre-eminence of markets in
resource allocation and rewarding of entrepreneurship,
economists continue to debate the economic role of
governments. This debate has been fueled by theoretical
insights brought about by the "New Theories" (as Robert
Gilpin refers to them): the theory of multiple equilibria,
which posits the possibility of persistent bad equilibria; the
theory of endogenous growth, which undermines some of the
basic constructs of neoclassical economics (such as "the law
of diminishing returns"); the thesis of "path dependency" (the
role of history), the importance of geography; the role of
information costs and asymmetries; and the role of clusters
in achieving competitive advantages (Michael Porter's use of
clusters in explaining competitive advantages reminds
Gunnar Myrdal's concept of cumulative causation), etc.
The New Theories rely on, and bring back to the
limelight, theses of the old development economics. Albert
Hirschman, Paul Rosenstein Rodan, Ragnar Nurkse, Gunnar
Myrdal, Harvey Leibenstein, and others highlighted the role
of institutions and structural features of poor countries,
which keep them hostage to various types of traps. That
suggests a need for development assistance or what Rodan
termed as the "Big Push" in a famous article written in 1943.
To sum up, the current debate on development
economics has rediscovered several of its old issues. In this
context, it re-emphasises the existence of externalities,
multiple equilibria, bad path-dependencies, vicious circles
and "underdevelopment traps", all of which pose numerous
challenges to public policy. It is increasingly obvious that
32

public policy (at the national and the international level),

while it has a role to play in order to address government
failures, also needs to address market co-ordination failures.
In this context, one needs to underline the importance of
good institutions and proper structures for public and
corporate governance, which condition the overall
performance of the economy. The wide variety of economic
performance in transition (post-communist) countries must
be related to the different functioning of institutional set-ups
and policy diversity.
It may be that we are on the verge of a new age of
development economics, seen against the backdrop of the
very disappointing record of economic advancement in most
of the developing world (excluding China and parts of India),
transition failures in many post-communist countries, andthe
backlash against "unmanaged" globalisation. Olivier Blanchard,
Paul Krugman, Dani Rodrik, Joseph Stiglitz, and others form
a remarkable platoon of brilliant economists, capable of
injecting more realism and creativity into development
policymaking.
Setimes 20.10.2003

ECONOMIC POLICY: THE END OF

IDEOLOGY?
The past decade has been suffused with claims that
economic policy, in the advanced countries, is being driven
by an emerging new consensus on principles and practice. In
the UK, the reinvented Labour Party has adopted Anthony
Giddens' "Third Way" as its mantra. During the 1990s,
33

highly glamorous seminars featuring Bill Clinton, Tony

Blair, Gerhard Schroeder, Lionel Jospin and others attempted
to explore the terrain between traditional social democracy
and unrestrained liberalism. George W. Bush's presidential
bid may have been helped by his choice of "compassionate
conservatism" as a campaign slogan. It has appeared as
though Social Democrats (in Europe), Democrats (in the
United States), center right parties (in Europe) and
Republicans (in the United States) were coming closer, both
in principles and in economic policy.
What are the sources of this apparent new consensus?
Arguably, there are several. Broadly speaking, it can be
traced to our ongoing desire to gain control over our
environment, particularly through greater efficiency. During
the first quarter of the past century, Max Weber's
"rationalisation of life" meant rational accounting, rational
law, and rational technology; the same principle can be
extrapolated to "rational economics" as a form of hard
science. In the 1970s, another famous sociologist, Daniel
Bell, upheld the primacy of knowledge and theory-related
activities in ordering our life and fostering man's
technological and economic ascendancy implying that
economic wizards could secure a foolproof policy.
Even the clash between Keynesianism and monetarism,
as the two main competing macroeconomic paradigms, could
be seen in the light of searching for the ultimate piece of
wisdom. Another origin of policy amalgamation is the death
of communism. Francis Fukuyama's "End of History" was
presumably seen by many as an embodiment of the single
ideology (liberal democracy), which was meant to rule the
world. Last, but not least, globalisation as an incarnation of
unfettered markets and the downsizing of government,
operating worldwide also provided an impetus to the vision
of an "ideal" type of economic policy.
34

At the start of the new century, facts are disavowing

oversimplifications. There are numerous examples which
demonstrate that conflicting ideas matter a lot, that reality
cannot be encapsulated into a procrustean ideological bed;
and that economics continues to be softer than some of us try
to make people believe. Let's be more specific. Policy-wise,
it is increasingly clear that trimming the welfare state and the
public sector is not sufficient to achieve the expected
efficiency gains; this endeavour needs to be accompanied by
effective regulations of various markets (financial and
energy, in particular), which otherwise can easily be rigged.
The "new economy" paradigm (which claimed to combine
high growth rates with very low unemployment) proved to
be, simply put, a mirage of the 1990s. The developments of
the last couple of years in the United States and elsewhere
offer ample proofs in this regard, motivating public
authorities to initiate the Sarbanes-Oxley Act. Likewise,
contrary to the prevailing tenets of not many years ago,
economic policy, as it is currently undertaken in the United
States and Europe, does not preclude running larger budget
deficits during a downswing of the cycle. This is the
explanation behind the return of some basic Keynesian
recipes to the limelight. It should be said, nonetheless, that
while Keynesian macroeconomics seems to be enjoying a
higher profile nowadays, the EU member countries are
simultaneously trying to make their markets (labour,
products, services, financial) more flexible.
How does globalisation fit into this picture? The
pressure of more intense competition forces governments to
streamline their public sectors, which frustrates trade unions
and many citizens at large. But rich countries, in the West,
remain welfare states par excellence, albeit in an evolving
manner. One can detect here a rising or returning
Keynesianism in macroeconomic policy-making, combined
35

with a retreat when it comes to social policy; the result is an

apparent policy contradiction. Another consequence of
globalisation is the creation of an international policy
agenda. By omission and commission, some of the wealthy
countries' less-inspired policies have given a renewed high
profile to issues such as fair versus free trade; dealing with
abject poverty in the world; protecting the environment as a
public good for mankind; the code of conduct for
international corporations, managing contagion effects in the
world economy; and policy co-ordination among the leading
economies of the world.
In fact, the traditional ongoing battle between left and
right within the framework of democratic politics is
being shifted partially onto the international arena. The
debate on global governance (that is, on institutions and
policies) reflects a growing awareness that there are issues
that need to be addressed internationally, in a multilateral
context and using collaborative approaches. Arguably, the
choice between globalisation and "managed globalisation" is
between accepting the effects of completely free markets
with total policy disregard for market failures and their social
consequences and trying to construct an international
policy, which should address or prevent massive
coordination failures. The debate over the most desirable
form of capitalism, and the most effective type of state
intervention in the economy, partially turns into a debate
over contrasting forms of "global capitalism".
The second policy route makes sense in a global
economy, in which there is acceptance of the need for
international public goods. Otherwise, under increasing
pressure from foreign markets and other threats (including
terrorism, illegal immigration and spreading diseases),
governments would resort to national means of protection
such as trade protectionism, trade clashes and competitive
devaluations.
36

Ideology is not dead. It shapes social and economic

policies although in subtler forms and following cyclical
patterns. It may be less often felt nationally to the extent that
the battlefield of ideas expands increasingly beyond national
borders. In any case, globalisation is likely to reflect more
and more the battle of ideas, with traditional politics delving
increasingly into the international domain. How
policymakers address the hot issues in the international
economy will provide clues regarding its dynamics.
Setimes -27.10.2003

WHO FEARS OUTSOURCING

AND OFF-SHORING?
The pros and cons of outsourcing and offshoring have
become the subject of vigorous debate in many countries.
Many economists believe a combination of factors
including high educational levels, low local wages and good
governance are necessary for countries to capitalise fully
on the advantages of a global economy. Southeast European
countries are well-positioned in terms of skills and wages,
but will need wise public policies in order to reap the
benefits of outsourcing within Europe.
Recent years have witnessed a rising choir of disquiet
in advanced countries as to the impact of global trade on
their economies. In the United States, leading politicians
from both major parties have objected to what they perceive
as multiplying runaway jobs due to outsourcing and
offshoring. The concerns are even more acute in Western
Europe; several French and German ministers have made
37

public their worries about industrial relocation. Former

French Finance Minister Nicolas Sarkozy and German
Economy Minister Wolfgang Clement have been especially
vocal. They have not hesitated to blame new EU member
states for allegedly practicing unfair competition via lower
taxes. How has it come about that advanced economies,
which have traditionally been staunch supporters of free
trade, seem to be having second thoughts?
Traditionally, the less benign side of global free trade
has been ascribed to its effects on countries that either cannot
make the best use of their comparative advantages, or that
face stiff protectionism from wealthy economies in certain
domains for example, farm products. In general, such
economies are to be found in the developing world, where
poor governance and the inability to absorb new technologies
are widespread. This state of affairs led Harvard economist
Dani Rodrik to remark that free trade is not necessarily
welfare-enhancing for poor economies.
There are both theoretical and realistic reasons for this
apparent partial turnaround in the public rhetoric coming
from affluent countries. In terms of economics, the
arguments that stress the virtues of free trade form the basis
for rationalising commercial exchanges among countries;
nonetheless, these arguments lose some of their power and
appeal when the distribution of gains is largely asymmetrical
and dynamic competitive advantages dominate. Years ago,
Paul Krugman and Elhanan Helpman wrote seminal pieces
on what they called "strategic trade". One can posit that the
economic rise of Asian economies (and most impressively
that of China over the last couple of decades) is to be judged
through such policy lenses namely, through strategic trade
policy, which was embedded into a sort of developmentfocused industrial policy by using market forces in a smart
way.
38

Nowadays, the new information and communication

technologies (ICT) bring about great opportunities for
developing economies, to the benefit especially of welleducated people. Again, Asian countries fare quite well in
this respect. The "India unbound" of the last decade is the
outcome of market-oriented reforms, taking place amid a
vast pool of English-speaking engineers and computer/
software specialists. At the same time, only some parts of
India have been touched by rapid economic progress, and
much of the country is still mired in abject poverty.
What matters in the global economic game is the
existence of substantial wage differentials among countries
and regions. It is this factor which drives industrial
relocation, as globally-oriented companies shift operations to
areas which combine cheap labour with adequate
technologies. The intensity of this process depends both on
the wage differentials and the quality of other production
factors. Leading mainstream trade economists, such as
Jagdish Bhagwati, argue that advanced economies have little
to fear, since they specialise increasingly in higher valueadded products and services; all countries, therefore, will be
better off in the end. This argument, however, has been
disputed recently by Paul Samuelson of MIT; writing in the
Journal of Economics Perspectives, he suggests that
"sometimes a productivity gain in one country can benefit
that country alone, while permanently hurting the other
country by reducing the gains from trade that are possible
between the two countries". Samuelson goes on to argue that
"post-2000 outsourcing is just what ought to have been
predictable as far back as 1950", since it is the result of other
economies around the world assimilating advanced
technologies and catching up with the United States.
Against a backdrop of new ICTs and global wage
differentials, major shifts in the distribution of industrial and
39

service activities are probably unavoidable. Moreover, some

leading industrial economies do not appear to be keeping
pace sufficiently with this process as far as restructuring is
concerned; the lag harms some of their labour segments, and
puts pressure on real wages. As a result, anxiety about
outsourcing and offshoring develops. It is easy to understand
why such anxiety exists in Western Europe, where wages are
a large multiple of what well-educated Eastern and Central
European workers earn. Although framed in global rather
than continental terms, the Lisbon Agenda was a product of
this fear. The big EU member countries primarily worry
about Asia and the US economy, and regard the Lisbon
Agenda as a competitiveness policy response.
The fear of outsourcing and offshoring can be seen as
analogous to the deep transformation depression of the last
decade in post-communist economies. These went through a
dramatic fall of output because resource reallocation at the
new market clearing prices could not happen rapidly
enough. Similar pains can be detected nowadays among
some groups of workers in rich economies, who cannot
compete in the new global economy, while policymakers
react one way or another. Protectionist measures in various
countries complicate the situation further.
The bottom line is that countries with a highlyeducated population, a substantial level of investment in
education and forward-looking public policies are the most
likely to enjoy the fruits of technology dissemination on a
global scale. Because Central and Eastern European
countries have comparatively well-educated populations and
low local wages, they stand to benefit greatly from
outsourcing within Europe. But they will need intelligent
public policies in order to make the most of this opportunity.
Setimes 31.01.2005

40

OIL PRICES, EMERGING ECONOMIES

RESHAPE GLOBAL PICTURE
Economists differ when it comes to interpreting the
significance of rising oil prices, which in real terms are
approaching those which triggered the stagflation of the
1970s. Optimists suggest that market balance will be restored
once supply side problems including bottlenecks in
refining capacity are resolved. Others, factoring in the
economic ascendancy of China and India, increased
competition for resources and the threat of global warming,
see a more complicated picture. In the past, the more
pessimistic scenarios have been partly invalidated by
technological advances and the operation of market forces.
Will that be the case again? A collision of issues economic,
political, strategic, and ecological suggests that
policymakers should not be complacent.
When the oil price went above $50 per barrel, the
world started to worry. When it reached $70 per barrel in
September subsequently slipping down to between $60 and
$65 analysts began looking carefully at the next threshold.
The reason is clear: in real terms. $80 per barrel is
equivalent to the price level which triggered stagflation in
the Western economies several decades ago. At that time,
Arab oil-producing countries used this strategic commodity
as an economic and political weapon; in several rounds, the
oil price escalated to over $40 per barrel. The price meant a
drastic and considerable change of the terms of trade
between the oil exporting and importing countries.
Wealthy, industrialised countries absorbed the oil price
shock through economic slowdown (even recession) and
heavy monetisation of their surging budget deficits. Over
time, the rise in the price of industrial products compensated
41

for the new price of oil. The combination of recession and

high inflation close to 20 per cent just before the advent of
Paul Volcker at the helm of the Federal Reserve
confounded not a few macroeconomists; they had a hard
time in accepting that massive under utilisation of resources
can cohabit with a much quicker pace of inflation.
Consequently, the conventional paradigm had to be extended
to take into account the scenario in which a powerful supplyside shock overpowers the ability of the economy to undergo
a smooth and fast reallocation of resources, as a means to
absorb that shock. In this case, recession combined with
higher inflation becomes inevitable.
Arguably, the Western economies experienced a shock
which, decades later, was to be felt on a much grander scale
by post-communist economies. Whereas the West had to
deal with a brutal change in the terms of trade for a strategic
commodity, post-communist economies had to deal with the
wide-ranging institutional reforms and resource reallocation
following the collapse of the Soviet trade bloc. Indeed,
Soviet bloc countries were partially insulated at the time of
the oil price shock, for they benefited from cheap oil from
the former USSR. Poor oil-importing economies were the
hardest hit, suffering a double blow: a much higher price of
oil, plus gradually rising prices of industrial products.
Today's higher oil prices thus raise a simple question:
is the current situation similar to that of several decades ago?
On the one hand, refining capacity bottlenecks indicate that
there is a supply side problem, which was amplified by the
consequences of natural disasters, such as the Katrina and
Rita hurricanes. Likewise, oil exploration has not been
expanded sufficiently in recent years. The policy implication
is that market balance could be restored were these supply
constraints eliminated. However, there is one major novelty
in the picture: the economic ascendancy of Asia and
42

particularly of China and India creates an additional,

growing pressure on the oil and gas market.
The big question, then, is this: What is the potential
impact of this new global economic picture on the price
dynamic of basic commodities, on which the functioning of
modern economies relies?
In a Malthusian, pessimistic scenario, further sharp
price rises can be envisaged, with a struggle for the control
of key resources. Let us recall the intellectual and policyrelated debates after the publication of the Meadows report
"The Limits to Growth" which was commissioned by the
Club of Rome more than three decades ago. Likewise the
modeling of global dynamics (the Forrester Model,
developed by the MIT professor Jay Forrester) was
stimulated in order to investigate what was likely to happen
in the wake of severe change of circumstances on
commodity markets. The Malthusian view was partially
invalidated by technological advances and by the operation
of market forces, which made the use of alternative energy
sources profitable at the new prices. Could we bet again on
technology and be complacent? Perhaps, but the answer has
to take China and India into account.
The demand side shock is likely to continue, with
Asian economies exerting pressure on the oil and gas market
in the years to come. Arguably, this alone posts that the price
of oil will not be returning to below $40 a barrel any time
soon. Furthermore, although the price hike has been
comparatively gradual, it is nevertheless forcing adjustments
in consumption and production. Once again, the most
severely hit are poor countries, especially those that import
energy.
Several implications can be drawn. The competition for
the control of oil and gas fields will intensify in the years to
come, impacting geopolitical and security related concerns; a
43

frantic search for new fields will be ushered in; oil and gas
will be seen even more as highly strategic commodities and
major economies will define external policies accordingly. It
is highly probable that the needs of industries to be more
competitive will collide with ecological concerns at a time
when the effects of global warming are ever more visible and
worrying.
Higher oil and gas prices slow down growth and lead
to higher core inflation. Hence, major trade-offs for both
firms and governments emerge, requiring policy clarity and
thorough calculations of costs and benefits. A new thrust for
energy conservation is to be expected under the new
circumstances. Private and public budgets will be
increasingly strained unless measures are enacted soon and
implemented consistently over time.
Setimes 3.01.2006

THE RACE FOR COMPETITIVENESS

At a time when US leaders are expressing concerns
about staying competitive, data shows that the EU is lagging
behind the United States. On the whole, the bloc has not
invested adequate amounts in research and development,
while productivity growth has been sluggish. Despite the
ambitious goals of the Lisbon Agenda, specific steps at
implementation have been mired in debate, and much
remains in the hands of European national governments.
Both the United States and the EU, meanwhile, face a
growing challenge from Asian economies; if the prospects
are enough to worry US President George W. Bush, then it is
surely time for a "wake-up call" in Brussels.
44

In his most recent State of the Union address, US

President George W. Bush touched on competitiveness
challenges, voicing concern that the United States risks
falling behind in science and technology. For citizens in the
EU, this "wake-up call" may have seemed surprising: from a
European perspective, the United States appears to be ahead.
A 2005 report from Conference Board, a high-profile
business organisation, showed that productivity growth in the
15 "old EU" member states was 0.5 per cent, as against
1.8 per cent in the United States (and 1.9 per cent in Japan).
For the period 1995-2005, annual growth in national output
for every hour worked in the EU-15 averaged 1.4 per cent,
compared with 2.4 per cent in the United States.
Likewise, data compiled by the European Commission
(EC) in Brussels also suggest the EU lags behind the United
States in key areas. Research and Development (R&D), for
instance, represented only 1.93 per cent of the bloc's GDP in
2003, as opposed to 2.58 per cent in the United States and
3.15 per cent in Japan. True, there is a broad variety in
performance across the EU, with the Nordic countries
overtaking the United States in terms of amounts invested in
R&D. For Sweden, Finland and Denmark these figures are
above 3 per cent. However, the stark truth is that the
heavyweights of the EU do not spend nearly as much in this
area as the EC thinks would be adequate namely, 3 per cent
of GDP.
The ambitious EC blueprint known as the Lisbon
Agenda was formulated with an eye to the performance of
US companies and the excellence of the American way of
blending academic research with high-tech and industrial
pursuits. For instance, the EC proposed setting up a
European Institute of Technology, modeled after MIT. The
idea was criticised as being a "top-down" approach, sucking
money and resources from the alternative option of
45

supporting high level research through a European Research

Council. Indeed, controversies have often arisen over
specific measures aimed at implementing the Agenda, and
much remains in the hands of European national
governments. However, it is clear that the United States
represents a kind of benchmark for policymakers, and it is
also clear that the EU has been sluggish in achieving its
goals in terms of competitiveness. The bottom line is that the
bloc faces a growing challenge.
The success of the EU's Nordic fringe has been due not
only to major R&D efforts undertaken both by governments
and private companies, but also results from flexible product
and labour market, as well as a clever overhaul of welfare
networks. The newer EU member countries seem to fare
comparatively well in terms of productivity growth; the 2005
report of the Conference Board indicates an increase of over
6 per cent in these economies, which have capitalized on
their catching up potential. Arguably, however, just catching
up isn't enough. Over the longer run, demographics and an
expected sharp rise in wages (according to the BalassaSamuelson effect) will diminish the growth differential
sharply, unless appropriate policies are put into effect.
If we are comparing the EU and the United States,
then, Bush's concerns might strike some as unjustified.
However, there is another factor to be considered: Asia.
China, India and other Asian economies are increasingly a
source of competitive pressures in the global economy.
These economies are absorbing advanced technologies at a
rapid pace and excel in innovation India's remarkable
engineering institutes, like those in Bangalore, can match the
best in the Western world. Scientists from Asian nations are
becoming an ever more noticeable presence in top scientific
journals, illustrating the region's potential to shape the
research agenda of the future.
46

When we introduce Asia into the picture, we can see

that the United States and the EU both face competitiveness
challenges, although the nature of those challenges is
somewhat different. For the United States, they appear to be
mainly related to global strategic interests, which in turn are
affected by the emergence of new global powers. For the EU,
they involve worsening demographics and the crises of the
welfare state, together with insufficient resources devoted to
R&D and the difficulties in managing complexity. There is a
common denominator, however: both the United States and
the EU will face increasingly stiff competition from Asian
economies.
A couple decades ago, global competition was defined
in a triangular formation: US-EU-Japan. The picture today
cannot be seen so simply. The evolving global economy
brings with it new major competitors and achange of
competitive hierarchies. Unless governments and companies
are clairvoyant and adjust to trends by investing more in
R&D and education, painful corrections will be likely in
store.
Those who believe that only non-zero games prevail in
the world economy do need a "wake up call" to reality. The
dramatic changes under way open up the possibility for cooperative relationships, but also for emerging tensions.
Consider, for instance, the growing need for energy and
basic commodities in Asia, with China and India as the
prime consumers, the unsolved geopolitical crises in various
parts of the world (in the Middle East in particular), nuclear
proliferation, and the visible and hidden aspects of the
struggle against terrorism. An array of developing trends
points the way to a highly uncertain world ahead.
Setimes 3.04.2006

47

WHY FAST ECONOMIC GROWTH

ISN'T ENOUGH
Conventional wisdom assumes that growth goes hand
in hand with political stability. That's not necessarily so.
Recent political developments in Hungary, Slovakia,
the Czech Republic and Poland have raised eyebrows among
observers worldwide. How can it be that after EU accession
domestic politics in these countries has stumbled in such an
alarming manner? Instead of a consolidation of democratic
politics, the post-accession period has seen fragmented,
stalemated governments, coalitions formed by mismatched
parties with incompatible philosophies, and in Hungary's
case an eruption of political tensions into public anger. The
trend is puzzling to many.
It pays to remember, however, that these economies are
part of the dynamic area of Europe, with annual economic
growth rates that have been many times higher than those in
the core of the EU (5-6% vs 1-2%). Conventional wisdom,
blending politics and economics, says that wherever
economic growth is high, social stability and sound politics
have a better chance of prevailing. In the case of Central
Europe, a logical inference would be that, owing to
significant economic growth in this decade, a large part of
the population would enjoy tangible economic fruits and,
therefore, support the ruling coalitions.
EU accession was expected to buoy the foundations of
these young liberal democracies. And there is another factor
to consider. Unlike citizens in most of the EU-15 (Portugal
and Spain are exceptions), people in the post-communist
countries have lived through the command system. One
would expect them to be better able to detect fake democrats
and cheap populism, be it on the right or the left. Orderly
48

democratic life would seem to be more alertly guarded in

countries that endured so long without it.
In fact, there is an ongoing debate among economists
about the fundamentals of economic growth, and about the
relationship between democracy and prosperity. Some argue
that growth matters first and foremost, even when it incurs
substantial inequities among social partners. Another line of
reasoning, however, argues that sustainable economic growth
should not impair social cohesion, and that it has to be
accompanied by adequate production of public goods. Good
practices in both the public and the private sectors, as well as
an effective fight against corruption, are key.
The experience of post-communist Mitteleuropa
suggests that high growth rates, in and of themselves, are not
enough to secure a sound social and political life. Arguably,
wherever in Central and Eastern Europe numerous citizens
have lost out in the economic race or have found themselves
marginalised (excluded from the fruits of economic growth),
their frustration is likely to be captured by extremist parties
and centrist parties lose political ground.
As for the buoying power of EU membership, this was
in a sense more effective when the countries involved were
hoping to get into the bloc. That hope enabled politicians
with differing ideological stances to rally citizens behind the
banner of a "return to Europe". More than a few of these
citizens saw this "return" as an initiation into a Nirvana-like
society, with immense economic benefits. Now people have
seen that nothing changed dramatically for the better after
May 2004. On the contrary, some additional pains have been
brought about by the rigours of complying with the EU
regulations.
A wake-up call was unavoidable. It has been amplified
by the revival of "economic patriotism" in the major EU
member states, a force which seems to contradict the very
49

principles with the bloc has been so earnest about imposing

on would-be members. In order to join the EU, Eastern
European countries diligently observed the intellectual and
operational matrix of the Union for instance, the total
opening of markets, including those for financial services
and public utilities. In these sectors, Eastern Europeans have
in fact been much more liberal that their western
counterparts. It is easy to comprehend the frustration in some
political circles in central Europe when EU heavyweights
preach what they do not practice.
Economic nationalism in the West thus spurs economic
nationalism in the East. Other issues add fuel to the fire for
example, Poland's fear of Germany and Russia, both of
which are working together in the very sensitive field of
energy procurement.
The memory of the past is not necessarily an effective
antidote to antiliberal sentiments. People enjoy their political
liberties and like to voice their satisfactions and frustrations,
but it is all too easy to forget how things were when such
liberties were non-existent and how that affected their lives.
Younger people who have no personal experience with
communism do not know what it is like. Their reference
points are different. In way that is not too dissimilar, some in
the West are oblivious to the second world war and its
atrocities, including the Holocaust.
Actual democracy and textbook democracy are two
different things. In practice, democracy means the
functioning, for better or worse, of checks and balances. The
actual state of democracy hinges greatly on the morality and
sense of accountability of political leaders, which can be
dismaying under certain conditions. It is for this reason that
some talk about a democracy deficit in EU member countries
and a shortage of responsible politicians, of true
statesmanship. More than a few myths and clichs are fading
50

away in the "New Europe", and individual and group

psychologies react one way or another.
Eastern European societies are much less prosperous
than their western EU partners. At the same time they are
facing similar structural challenges: aging, the crisis of the
welfare system, identity-related confusion, and a rising
pressure of immigration. High economic growth is not a
panacea. It will not forestall a political reaction if
governments prove incapable of dealing with the social
challenges that accompany modernisation, against the
background of globalisation. There are no easy solutions, and
national politicians will be severely tested in this respect in
the years to come. What they do will influence domestic
politics and their countries' economies greatly.
Moreover, what is happening in Central Europe should
sound warning bells when it comes to the Balkans. SEE
countries are also making the transition from communism,
with all of the hopes and disappointments this entails.
Economic woes, including unemployment, are substantial.
"Enlargement fatigue" and other barriers have made the
prospect of EU entry remote for some countries in the
region. They face the same pressures that have fostered
instability in Central Europe, but with less of an anchor to
keep them on a steady course.
Setimes 6.11.2006

THE SOUL OF CAPITALISM

The free market system, driven as it is by the profit
motive, is sometimes portrayed as being intrinsically
valueless and amoral. Yet there is a strong tradition that links
51

capitalism to ethical behavior, seeing the latter both as a

check on excesses and as necessity for achieving success in
the marketplace. It is sometimes forgotten that Adam Smith,
widely regarded as the father of economics, also authored
"The Theory of Moral Sentiments", and that Max Weber, the
famous sociologist, connected hard work and moral values
with the advance of capitalism in the western world.
In the wake of the Enron, Worldcom, Parmalat and
other scandals, renewed attention was paid to the ethical
underpinnings of a sound market economy. In Romania, too,
a series of business scandals linked with privatization deals
and the regulation of markets have captured the attention of
the Romanian public. Evidence of shady dealing and other
malfeasance has angered many people, leading some to
suggest that Romanians as a whole are hesitant about
embracing capitalism. This line of reasoning, however, is
one-sided, over-simplistic and misleading. It is one thing to
suggest that people crave a more decent form of capitalism,
and quite another to say they disdain capitalism altogether.
Capitalism's undeniable virtues enabled it to win the
ideological battle with communism and the command
system. In terms of resource allocation, market-set prices and
the ability to calculate costs and benefits transparently, a
market economy has clearcut advantages. But there is more
to the story. Capitalism cultivates a particular virtue:
entrepreneurship. As industrious as managers and
policymakers may be, it is often a different figure the
entrepreneur who is best able to identify major new
opportunities and capitalise on them.
Hayek, Kirszner, Rothbard, Schumpeter and the
Austrian School in general have made an essential
contribution to explaining the role of entrepreneurship in
economic development. Without entrepreneurs and their
blend of visionary and practical thinking, progress would be
52

much slower. Consider what Bill Gates has meant in the

history of Microsoft Corporation and even the IT industry as
a whole, or the way a team of gifted managers at Nokia have
turned the Finnish firm into a star of the world
telecommunications industry.
However, such figures share the marketplace with far
less honourable sorts. And capitalism itself comes in a
variety of forms, not all exemplary. In many Latin American
countries, for instance, it has been accompanied by oligarchs,
extreme income polarisation, civil unrest and occasional
outright warfare, as well as frequent breaches of civil
liberties. In Asia, a statist form of capitalism puts its imprint
on domestic politics, which typically has an authoritarian
bent. When people idealize capitalism, they usually do so
with reference to the "liberal democracies" the United
States, the EU, Canada, Australia, New Zealand. But even
the liberal democracies are not monolithic. Some have made
a plausible distinction between the so-called Anglo-Saxon
model and a "continental" model. The former is more liberal
in the European sense, while the latter is more attentive to
social issues.
Moreover, capitalism evolves. More precisely,
individual and group rationality which refers to capacity to
learn affects behavior, organisational life and policy. For
instance, some now criticise the harshness of the SarbanesOxley legislation the Public Company Accounting Reform
and Investor Protection Act of 2002 because of what it may
entail for competing in the global economy. On the other
hand, such legislation was demanded by an outraged
American public, in response to the inadequate functioning
of financial and energy markets, not to mention numerous
conflicts of interest and abuses of power. The Great
Depression, too, necessitated the introduction of strict
measures in order to rescue capitalism from its own perils.
53

Unbridled market forces can bring about havoc and misery

to too many people and public policy has a role to play to
avert it.
A simple dichotomy between capitalism and
communism may have made sense in 1989, but is far from
meaningful now. Rather, the significant question today
concerns what forms of capitalism are evolving in Central
and Eastern Europe, and in other areas of the world. EU
entry does not give a clearly defined answer to this question.
The degree to which laws are observed and markets function
in EU member states is of continuing relevance. The
business world has rules of decent conduct. Without such
rules business would turn into a jungle. When rent-seeking
and corruption are ubiquitous, when politicians and judges
can be easily bought, economy and domestic politics become
rotten. This is not the type of capitalism that can make the
majority of citizens happy and dignified. I prefer the
capitalism of Bill Gates to that of Michael Milken and
Ivan Boesky.
The need in the EU to cope with the pressures of
globalisation and demographics is not a reason to dismiss
morality and the need for mutual respect. In an enlarged
Europe we need a capitalism that performs economically and
socially. For this to happen, the liberty of markets has to be
accompanied by the rule of law, which should punish those
who are careless about and disrespectful of public interest.
An overbloated and corrupt public sector must be
combated fiercely, and there is still much to do in the new
EU member countries to this end. At the same time, one
should not close their eyes to wrongdoing in the private
sector as well. In order to be embraced wholeheartedly by
citizens, a market economy requires a moral compass. Profit
seeking is the essence of a market economy, and without
efficiency progress is unimaginable. But when values and a
54

sense of direction are lost, social cohesion melts and the

system breaks down. It is the responsibility of public policy
to try and correct malignities that affect the functioning of
markets and to deal with the social fallout of greed, lack of
honesty and cynicism. A decent capitalism requires such
policymaking, just as it requires the virtues found in
individual beings as they strive in pursuit of happiness and
material rewards.
Setimes 2.01.2007

55

PART II
WHICH WAY GOES
THE EUROPEAN UNION

THE EU'S BIGGEST CHALLENGE:

MANAGING RISING COMPLEXITY

The recent EU summit in Thessaloniki reaffirmed the

Union's decision to admit ten new members next year, and
sent an additional signal to countries in the Western Balkans
that they eventually would join as well. The summit was also
important because of its attempt to define more clearly a
common stance in the areas of defence and security, at a time
when the relationship with the United States needs to be
strengthened to meet the threats of the 21st century
effectively. Geopolitical and security concerns have been
very much at the forefront of the Union's agenda in recent
years, and the next wave of enlargement is being viewed in
this context. It would be a mistake, however, to overlook the
most serious challenge facing the Union: how to manage its
increasing complexity.
There are several ways of defining rising complexity.
One way is in terms of the Union's geographic expansion
not a trivial development when it involves added arrears,
which evince specific institutional traits and large gaps in
economic development. During its next wave of
enlargement, the Union in a sort of big bang approach
will take in a cluster of nations which have, on average, per
capita incomes that are significantly lower than the EU
average. An analogy with the accession of Portugal and
Spain decades ago is instructive, but of limited value. Both
of those countries benefited from a large array of lasting
derogations from EU rules, allowing them to catch up
59

economically, and their accession occurred in a period of

increasing well-being for the EU member economies. But
derogations are restricted now, and the economic state of the
EU is under considerable strain. Moreover, "reverse
derogations" are being put in place, such as restrictions on
labour movements from new to old EU member states.
For this reason, EU expansion raises a series of
questions related to the Common Agricultural Policy (CAP)
and to structural and cohesion funds. It is true that CAP
reform appears to be on the brink of a breakthrough in the
sense of delinking production of subsidies but much still
has to be done.
The wider economic disparities in the enlarged Union
give a higher profile to the challenge of convergence, both
real and nominal. It is not clear that structural and cohesion
funds alone are capable of reducing these disparities, so that
common policies can be effective. There are two salient
aspects to the question. One has to do with the impact of
large discrepancies on the functioning of the Union, when
some markets labour markets, for example show
significant rigidities. Another issue is that of dissimilar
economic conditions among EU member countries, which
may require differentiated policy responses. These, however,
are much less feasible because of the single currency and
common monetary policy. The current pains several large
economies are experiencing in meeting the Financial Stability
and Growth Pact are quite telling. Arguably, such difficulties
are not simply rooted in the effects of the business cycle, and
may not be alleviated by fiscal harmonisation.
The aspirant countries need to grow economically in
order to meet the demands of their populations and to help
the Union function smoothly. Most of them, in fact, do have
important assets, such as a vast pool of highly skilled and
comparatively inexpensive labour, relatively good
educational systems and geographic proximity to their main
60

markets.These assets provide cause for optimism. But the

strictures of the Maastricht criteria (which concern the level
of inflation and interest rates, the size of budget deficits and
overall public debt) may be too constraining when it comes
to achieving higher growth rates as the means to catch up
economically; too low targeted inflation rates would likely
impair growth in economies where significant productivity
gains in the tradeable sectors would push up the prices of
non-tradeable goods too far. One can hypothesise differently
and argue that sound macroeconomics and markets which are
more flexible than those in the "old" part of the EU might
provide a competitive edge to the new members, allowing
them to cope with the inflationary pressure entailed by
the advance of prices in the non-tradeable sector. But is it a
sure bet?
The EU needs substantially more convergence,
nominal and real, so that its "heightened variety" following
enlargement does not diminish its overall economic and
related political performance. Rising complexity does not
necessarily involve less homogeneity and convergence. But
as things stand currently, this is an open question which
needs to be addressed by policy and institutional reforms.
These reforms bear not only on the economic prospects of
the current members of the Union but also on those of
aspirant countries. For instance, Bulgaria and Romania have
their own very complicated and demanding reform agendas,
both institutional and economic. And they have to move
forward with these reforms resolutely so that their prospects
for joining the EU are not harmed. At the same time, the way
the Union manages its rising complexity is likely to play an
increasing role in the years to come, in terms of enhancing or
hindering the accession chances of the two countries.
Political and geopolitical concerns appear to have
driven enlargement more than economic ones have.
Undoubtedly, enlargement brings about its own economic
61

benefits. But unless properly managed and bolstered by

internal EU reforms (CAP, competition policy, the pension
systems, etc.), enlargement could fuel tensions among
member countries and decrease the likelihood of admitting
other aspirant countries. There are so many stakes involved
in adequately managing the Union's rising complexity that
failure to do so would prove a terrible blow to all European
countries, whether "in" or "out" of the club. But it must also be
acknowledged that such management is a very tall order.
Setimes 4.08.2003

IS THE EUROPEAN MODEL SUSTAINABLE?

Recently, I sat on a panel that discussed whether or not
the "European Model" is sustainable. The debate was not a
pure intellectual exercise, since this model assuming it can
be said to exist influences policymaking both within and
outside the EU. The entire project of the EU, according to
politicians, is aimed at giving a special economic and social
meaning to European societies, one that goes beyond the
quest for international competitiveness.
While the claim in favour of the existence of such a
model has its merits, it is not indisputable. On the one hand,
one can find features of capitalism in Europe that are
distinctly different from what is generally called the AngloSaxon variant, as well as from the type encountered in Asian
affluent societies. On the other hand, the welfare state,
although in a varied form, is a ubiquitous trait of advanced
capitalism worldwide. Moreover, some convergence among
the patterns of functioning of capitalism has taken place in
the last couple of decades under the spell of globalisation.
62

Significant social and economic variety exists inside

Europe. People differentiate between a Scandinavian model
(with its emphasis on social redistribution), the British model
(which is closer to the American model), and a
Mediterranean model, which seems to be of a more
"disorderly" sort although the bulging budget deficits in
Germany and France have cast some doubt on this
assessment. Some analysts point at the EU aspirant countries
from Central and Eastern Europe as examples of a more
liberal (in the European sense) form of capitalism. So where
does that leave us with regard to the European model?
To answer the question posed above, I would argue,
one should not underestimate the influence of EU
construction as a process of depth and large scope. The EU
project can be considered along at least two lines. One line is
rooted in the construction itself, which aims at spreading
common standards throughout the Union and imposing
common rules of policymaking and institutional set-ups. I
would mention here the Social Charta, which is an attempt to
make the social dimension of the Union more uniform.
At the same time, the EU project mired in the throes
and policy dilemmas and trade-offs of enlargement and
deepening faces the challenge of managing increasing
complexity. The Union increasingly assumes a common
denominator in various social and economic areas. But it is
strained by a highly visible contradiction between its wellentrenched social model and the need to make markets more
flexible. This contradiction would not be so acutely felt in
the absence of tremendous pressures exerted by globalisation
and by the competition from low-wage economies (including
Eastern European neighbouring countries).
Globalisation, and particularly the liberalisation of
finance and trade, undermines the lavish welfare state in
Western Europe. Social assistance is trimmed down by
63

necessity and pension systems are being overhauled. This

painful and politically very sensitive undertaking is taking
place against the background of population ageing, which is
an underlying demographic dynamic in Europe and
elsewhere.
In general, European citizens are being asked by their
governments to rely more on themselves and to ask less from
the state. Although globalisation has a non-trivial ideological
component, the forces at work have acquired a powerful
momentum of their own, which is driven by technological
change and intensified competition. The latter can be
restrained by bouts of protectionism (in trade and
competitive devaluations) and security concerns, but its
power currently seems to be unassailed. What lies in the
more remote future depends on many social, economic and
political variables, and history has some relevance in this
regard. It is instructive to recall what followed the Victorian
period of the 19th century, which is considered by many
historians as epitomising liberalisation at the high end,
including the free flow of labour.
Arguably, globalisation increasingly shifts the
ideological confrontation between left and right in
democratic societies into the international arena. This can be
seen in such phenomena as the anti-globalisation backlash in
rich countries, the stalled trade talks, and the enhanced
international competition between social democratic and
centre-right parties. The soul-searching process addressing
global poverty, and exemplified by the work of International
Financial Organisations, can be attributed to the same
development.
How the European model evolves in the future hinges
on several factors. One is linked with the management of
increased complexity. For the sake of economic and social
functionality, the EU will have to find more appropriate
64

institutional and policy constructs. The clash of paradigms

and ideas will shape things as well. For instance, the largescale failures in financial and energy markets have ushered
in a new period of market regulation, which reshapes public
policy accordingly (The Sarbanes-Oxley Act in the United
States is a clear example).
Policy pragmatism is in much higher demand than
policy fundamentalism, though hard-nosed ideologies are
present in the corridors of power. Public policy has been
forced to reconsider the theses of older times, such as the
need for the state to provide public goods, in order to regain
moral ground lost to corporate scandals. That issue relates to
domestic as well as international politics. For the latter,
issues such as environmental protection, containing and
combating diseases in the poor world, securing drinkable
water and fighting poverty make up an urgent agenda, one
which would help deal with international terrorism too. In all
these areas, the European Model has something relevant to
say and do. But if it is to succeed, it has to make a significant
contribution to how the world evolves in the years and
decades to come, economically, socially and politically.
Setimes 8.12.2003

AGRICULTURE AND THE DOHA TRADE

ROUND
Events have kept much of the world's attention focused
on Iraq and the Middle East. Geopolitical concerns and the
threat of terrorist acts are shaping the agendas of many
governments. These concerns, however, cannot obscure the
deteriorating economic situation in many parts of the globe,
65

which face low or slowing GDP growth rates, high or rising

unemployment, trade clashes, spreading social destitution,
inability to respond to natural disasters, and other problems.
Since the United States is the engine of the world economy,
some hopes are tied to signs of a US economic recovery, but
ongoing stagnation and even recession in Western Europe
dims the broad perspective.
In such an environment, developing countries fare
worse socially, economically and politically. Economic
distress in most of Africa, as well as in parts of Latin
America and Asia, is accompanied by faltering institutional
structures, by social fragmentation and disintegration, and by
interethnic conflicts and violence. Multiplying cases of failed
states compound an increasingly worrisome dynamic.
These trends provide an important context for the
WTO meeting in Cancun. When the Doha trade round was
initiated, many hailed it as a means not only to arrest rising
protectionist tendencies, but also to redress a major
imbalance in world trade. Within the context of the recurring
debate over free versus fair trade, the Doha round is
supposed to tackle what are probably the most inequitable
aspects of world trade: a highly restricted access, for
developing countries' farm products, to rich countries'
markets, and the heavy subsidisation of agricultural
production in rich economies, undermining farm production
in developing countries.
Farm products are the main export item of many
developing countries. In poorer countries, meanwhile, food
expenditure accounts for a large share of people's overall
spending. The United States and the EU spend about 280
billion euros annually on farm subsidies, but their aid for
development amounts to only around 50 billion euros. The
heavy subsidies maintain excessive levels of output in rich
countries and allow their farmers to compete unfairly against
poor countries' farmers.
66

One should not underestimate the serious obstacles in

the way of meeting poor countries' legitimate demands.
Farmers comprise important, politically influential lobbies in
rich countries, making reforms difficult to implement.
Security considerations also enter the picture, particularly in
a period when non-conventional threats and the need to
avoid excessive dependency on foreign sources of
procurement are receiving an ever higher profile.
Nevertheless, it is hard to dispute the major flaw in the
current arrangements, which penalise poor countries'
peasants and harm development prospects. For years now,
the World Bank has underlined this inimical state of affairs,
and top US and EU officials have acknowledged the stark
facts. But narrowly-defined national interests have dented
meaningful reform progress.
Recently, the US and the EU reached an agreement on
farm trade, which should enhance the talks in Cancun. As
analysts have aptly observed, however, the deal does not
offer any concrete figures for tariff and subsidy cuts, not to
mention non-tariff barriers. As a result, the deal looks more
like a letter of intent, devoid of numerical significance. The
Cancun meeting could be further weakened if progress in
trade (especially in farm trade) is linked with demands on
non-trade rules. The EU seems adamant about undertaking joint
negotiations on investment rules, competition policy and other
non-trade regulations. These rules the so-called "Singapore
issues" are important, but not so critical at this stage of the
overall debate. Unless wisely formulated and implemented,
non-trade rules may not advance the economic development
of poor countries. As things stand now, the non-trade issues
would arguably overload the Doha agenda and diminish the
Cancun meeting's chances of success.
The countries of Southeast Europe have large
agricultural sectors. Agriculture provides, in general,
between 8 and 20 per cent of GDP; in Albania's case, the
67

figure is nearly 50 per cent. Large segments of the

population live in rural areas. At the same time, productivity
is low, and public budgets cannot help much. Unless farming
gets a technology/productivity boost and market access
improves in the EU, the lot of farmers in Southeast Europe is
bound to worsen. Together with high unemployment in the
region, this would strain local economies more and aggravate
social frictions.
The less developed countries of Europe need easier
access for their farm products on EU markets, a fact which
provides a strong argument for reform of the Common
Agricultural Policy (CAP). On the other hand, those of
Europe's poorer countries which have a good chance of
joining the EU are interested, for social reasons and because
of their large rural populations, in the maintenance of
substantial farm subsidies. For them, subsidies would offer a
safety net at a time of deep retrenchment of public budgets.
Among the countries which are to join the EU in 2004,
Poland and Hungary face this predicament. It is even more
serious for Romania and Bulgaria, which have larger rural
populations. The Western Balkans would experience the
same dilemma: a need for better market access, combined
with the aspiration to join the EU and get farm subsidies.
One sees, therefore, that the CAP, which is perceived
as a major nuisance for world trade, can induce ambivalent
policy attitudes among EU accession countries. Most of the
latter wish to join a rich club; however, their economies are
not sufficiently competitive. Social destitution in rural areas
could get out of hand unless non-farm job creation is intense,
effective social safety nets are put in place, and outward
labor movement takes place with few restrictions.
At the same time, the Doha trade round remains vital
for the development of poor countries, and EU accession
countries need to look at the broad picture. For Balkan
68

countries which have remote prospects of joining the EU

(and, consequently, are less interested in farm subsidies), a
successful Doha trade round would imply better protection of
their domestic production and easier export access for their
farm products. But for the Doha trade round to be completed
successfully, visionary statesmanship among the leaders of
the developed countries, deep concern for the poor of the
world, and related adequate policies have to get the upper
hand.
Setimes 22.09.2003

STATES MUST BALANCE TAX

COMPETITION IN EUROPE
Fiscal policy in reform-minded transition countries has
been shaped by three key priorities: simplifying the fiscal
system, establishing transparency and clear procedures, and
ensuring that legislation is applied fairly. Over time, it has
also become increasingly clear that tax hikes for the sake of
increasing budget revenues can be self-defeating, and that
public authorities should limit contributions to social security
funds in order to stimulate job creation and the development
of small- and medium-sized enterprises. These lessons can
be seen within the context of government efforts to
streamline expenditures in order to keep budget and current
account deficits under control.
At the same time, more than a few transition countries
have grasped fiscal policy as a potent tool for attracting
Foreign Direct Investment. During the 1990s, Central
European countries used tax holidays and other fiscal stimuli
for this purpose. The resulting impact on the volume and
69

amount of capital inflows helped turn these economies

around and improved their competitiveness. While red tape
and corruption are most often cited by investors as obstacles
to business expansion, fiscal policy matters also.
How meaningful fiscal policy and tax competition can
be is illustrated by Slovakia's success in inducing Hyundai to
invest in a major automotive project. The country competed
fiercely with its neighbours, combining wage comparative
advantages with impressive financial resources. This
example can be viewed from two perspectives. One is with
regard to the entry of ten new countries including eight
formerly communist countries into the EU. It appears that
joining the Union compels member states to seek legislative
uniformity. Even so, there are areas in which national
prerogatives remain significant, resulting in visible
differences even when the general policy principles are the
same. Tax legislation is one such area.
A second perspective relates to the ability of
governments to use fiscal policy in order to foster more
business. Some new entrants into the EU are lowering taxes
to such a degree that old members are talking about "unfair
competition". Slovakia has introduced a single income tax
quota (19 per cent), emulating the model Baltic countries
have experimented with for years.
Corporate taxes have also been recently lowered in
Poland and Hungary. The policies of these Central European
countries have prompted varying reactions among the older
EU member states. Austria, for instance, has determined that
it must come up with similar policies in order to stem a
possible capital flight. Germany and France are arguing that
tax competition is reminiscent of competitive devaluations,
in which exchange rates are used to enhance export
competitiveness. The result, they warn, will be losses for
everyone. The French and Germans also insist that it is not
70

appropriate for countries benefiting from EU structural and

cohesion funds to practice tax competition against the
donors.
Although national fiscal policies present a wide range
of variation within the EU, the reaction from some of the
more established member states should not be
underestimated. Strained welfare systems and high wages are
speeding up outsourcing, offshoring and job losses. At the
same time, the EU's lack of success in implementing the
goals of the Lisbon Agenda which aims to make the Union
the most competitive area worldwide in terms of a
knowledge-based economy reinforces these fears. It may
be only a matter of time before the European Commission in
Brussels sets about defining "rules" intended to govern tax
competition inside the Union.
Meanwhile, candidates and would-be candidates for
EU membership are caught up in conflicting policy thrusts. It
is clear to Bulgaria, Romania and Croatia that they cannot
simply overlook what their neighbours are doing, and that
they must simplify and optimise their tax systems. Romania,
for instance, must reduce its social security contributions to a
much lower level. At the same time, these countries have to
find ways to keep their budget deficits under control, while
locating additional revenues necessary for funding
development projects.
Tax competition presents both opportunities and perils.
Lower taxes can stimulate business and, under the right
conditions, increase budget revenues. Pushed too low,
however, they can be inimical to budget revenues and
endanger public goods such as infrastructure, education and
healthcare.
In relatively poor countries, including many in
Southeast Europe, it would be wishful thinking to expect
such goods to be provided solely by the private sector. True,
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more and more discussion is taking place about the role of

public-private partnerships in developing infrastructure in the
Balkans. But when per capita income is low, and much of the
population has a difficult time making ends meet, such
partnerships will not be able to provide all the answers. The
state necessarily remains a major provider of public goods,
and international financial institutions play an important role
in assisting local governments to this end. Governments have
to find the right balance. They must seek to improve
efficiency and keep their fiscal systems competitive, while
not going too far with taxation experiments.
Setimes 12.07.2004

MAINTAINING LOW INFLATION

IN TRANSITION ECONOMIES
One-digit inflation rates have become a general feature
of European transition economies. This is good in itself, and
also an advantage for the transition countries which have
joined, or wish to join the EU. An important question,
however, is whether low inflation rates will be maintained
over the longer run, in view of EU requirements.
According to one line of reasoning, a trade-off exists
between growth and inflation in transition economies
because of the so called Balassa-Samuelson effect. Within
this context, it is worth examining a relatively new monetary
policy regime known as "inflation targeting" (IT). The
countries that have pioneered this system include New
Zealand, Canada, Chile, Israel, the United Kingdom,
Australia and Sweden. During the late 1990s, it was adopted
officially by the Czech Republic, Poland and Hungary.
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Under IT, the central bank manages monetary policy

instruments with the direct goal of containing inflation over
the medium term. Inflation becomes the overriding goal of
monetary policy. All the other indicators (output gap, money
stock growth, the exchange rate) become auxiliary variables;
the central bank takes them into account only if this
information helps improve its inflation forecast. These
forecasts are contingent upon the central bank's view of the
transmission mechanism, the current state of the economy
and a planned path for the instrument. Complex econometric
modeling and statistical inference-building based on highquality data and economic information is needed in order to
produce reliable forecasts. A subjective assessment of the
inflation path may be included also.
From the implementation point of view, a basic
prerequisite for inflation targeting is the central banks full
autonomy. The relevant price index must be defined; in
general, it is a traditional consumer price index. Countries
adopting IT must then choose the target and range, and the
bank must decide which instruments it wants to utilise. In
recent years, central banks all over the world have chosen to
have a say regarding short-term interest rates, mainly
through reverse-repo operations carried out in the money
market.
Many influential economists argue that inflation
targeting rules out an inflation bias because the central bank
has a single goal under this regime: price stability. Thus,
there can be no conflicts of interest between multiple
objectives, such as the standard conflict between inflation
and economic activity. The policymakers accountability
should be quite high under IT since performance can be
directly measured, for instance by the deviation between
actual inflation and the target.
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However, the benefits theoretically arising from IT

may not be so easy to achieve, particularly within the context
of less-developed transition economies. The European
Central Bank (ECB) has decided not to adopt monetary
targeting, since in a new economic environment one
characterised by a wide heterogeneity among member
countries, with new monetary institutions and a money
market in ongoing development it is impossible to infer,
from scarce data, a reliable money demand function. Like the
United States, the European Monetary Union aims to address
a variety of threats to price stability, including exceptional
events such as deflation, war, terrorist attacks, import price
shocks or stock market crises.
In developed countries, adoption of IT implies that the
central bank has the technical ability to make a reliable
conditional forecast of inflation, and can adapt its
instruments in order to bring the forecast close to the target.
All the benefits which derive from IT in terms of
accountability and credibility stem from these conditions.
However, obtaining a reliable conditional forecast is a very
difficult challenge, one which the ECB itself has not
undertaken. What if the forecast is wrong? The relationship
between the instruments is generally assumed to be known;
but is this relationship carved in stone for a developing
economy with significant structural fragility?
The overall performance of the IT group of countries is
not very conclusive. A series of studies indicate that inflation
targeting has, on the whole, proved to be a successful policy.
It appears that IT reinforces accountability, credibility and
resilience to external shocks, and helps high-inflation
countries reduce inflation to normal levels. At the same time,
these studies demonstrate that inflation in IT countries is not
lower than in non-IT countries. In transition economies the
experience is mixed. Central banks in these countries have
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often missed inflation targets by a large margin. In the Czech

Republic, Hungary and Poland, progress with disinflation
has been good, but the persistence of a relatively high level
of uncertainty makes it difficult to predict inflation over the
medium term, as required by the IT approach. This is not a
minor shortcoming. It provides a lesson for other transition
economies which are thinking about adopting IT.
For IT to prove beneficial, the proper conditions must
be fulfilled, or the central bank risks losing credibility. There
is a significant possibility of making the wrong forecasts and
missing inflation targets. Thus, it is not advisable to adopt a
rigid framework for monetary policy management if
the criteria for smooth functioning of the system are not
being met.
Furthermore, as recent data show, inflation in almost
all the Central and Eastern European countries has been
following a downward trend, irrespective of the choice of
monetary arrangements and regimes the central banks of
these countries have employed. If sensible domestic fiscal
and monetary policies are being pursued, there are no
reasons to think disinflation should not continue in the
absence of a genuine IT regime.
Setimes 6.09.2004

EU REFERENDA COMPLICATE
ACCESSION PROSPECTS
The results of the referendums in France and Holland
have demonstrated the depth of socioeconomic and political
currents which have been present in a number of EU
countries for years now. Many citizens are frustrated about
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the way the Union's enlargement has been unfolding. Flaws

in the institutional set-up, which triggered the working out of
the Treaty, combine with the erosion of the welfare state and
the effects of globalisation to produce a volatile political
dynamic. The talk about a democratic deficit in the EU is not
without substance; rather, it reflects a schism between
political elites and the population at large.
There is a considerable variety of economic
performance within the Union, with Scandinavian countries
well ahead of Mediterranean ones in terms of GDP growth
rates, employment, budgets and other factors. At the same
time, a sense of stagnation among the older EU members is
easy to discern. By and large, the Treaty of Rome signatory
states are in the grip of economic fatigue.
The relative merits and disadvantages of the AngloSaxon and Continental models are a source of ongoing
debate. There are countries (Denmark, Finland, Sweden) that
have not dismantled the welfare state and have achieved
good economic performance while also scoring at the upper
end of the EU spectrum in terms of fulfilling the targets of
the Lisbon Agenda (which aims to boost competitiveness
throughout the EU area). National experiences indicate,
therefore, that actual economic performance depends on
concrete institutional set-ups, which may or may not help cope
with economic and technological change.
Western European economies are confronted with
social challenges which are rooted in the ageing populations,
falling birthrates, a certain institutional sclerosis (which
recalls economists Douglas North's and Mancur Olson's
writings about the hijacking of public policy in market
economies by vested interests), immigration and the
competitive pressures generated by the new information and
communication technologies and globalisation. More than a
few EU member states have witnessed an increasing divide
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between, on the one hand, those who are capable of

weathering the shocks produced by globalisation and new
technology and, on the other, those who succumb to pressure
and enroll among the ranks of the marginalised and
disgruntled. EU member countries face increasingly intense
competition from low wage countries, in the form of what is
often called outsourcing or offshoring. This has become a
major political theme in Western Europe as well as in the
United States.
How public policy can respond adequately to social
and economic challenges is not easy to work out. The
problems are quite clear, but policy answers involve complex
trade-offs and painful adjustments. Frequently, co-ordination
failures plague policy. Situations differ widely among
various countries, although many have at least one thing in
common: public budgets that are increasingly under strain.
For instance, German companies excel at raising productivity
and competing on foreign markets, but unemployment
remains high at home and the public budget is well above 3
per cent of GDP. By contrast, in Italy competitiveness both
at home and abroad is a source of worry for political and
business elites, while the public budget appears to be
spinning out of control.
It is increasingly clear that finding a way out of the
whole requires reform of the welfare state, in combination
with public policies designed to stimulate R&D for the sake
of enhancing competitiveness. Otherwise, gradual decline is
almost inevitable. The achievement of Scandinavian
countries in the past decade suggests a policy venue which
could be replicated, more or less. Germany seems to have
embarked on this road, although it faces heavy social
opposition to painful measures. One way or another, the
social contract between citizens and states has to be
rewritten, preserving the basic ingredients of the welfare
77

system while giving economies more flexibility and capacity

to face global competition. Arguably, this presents the
biggest challenge for the old EU member countries in the
years to come. That this endeavour is inescapable is amply
indicated by the response of people in the Western European
countries to the recent round of enlargement. By bringing
into the Union a number of low-wage economies, the
eastward expansion amplified fears, among the existing
member states, of runaway jobs, declining wages and other
globalisation-era pressures.
EU enlargement can be looked upon as a facet of
globalisation, which frequently attracts blame for economic
woes. Indeed, the rise of China and "India Unbound" has the
potential to shake up what had previously seemed to be wellentrenched hierarchies. But it pays to ask ourselves whether
the relapse into protectionism is the proper solution to the
intensity of competition in the world economy. It is one thing
to accuse low-wage countries of using unfair means (such as
the exploitation of children), and another to blame them for
capitalising on low wages to boost their exports. Low wages,
by themselves, are not an unfair competitive tool. Is there
any moral basis for asking lower-wage countries to slow
their progress because of the damage this might inflict on
stagnant economies in Western Europe?
EU member states cannot avoid the need to stay
competitive, which in turn requires revamping welfare
systems and achieving technological change. But these
objectives are time consuming and not easy to undertake
socially. Politicians have to be more candid and persuasive in
what they say and do. They have to form coalitions of
interests in society that can support reforms effectively.
The EU is going through hard times, a fact which
complicates Bulgaria and Romanias scheduled accession in
2007. Under the current circumstances, the possibility of a
78

one-year delay is high. More MPs in the West are talking

about halting, or indefinitely postponing, the enlargement
process. This is not good news for the rest of Europe, in
particular the Western Balkans, which has come to rely on
the EU anchor as a powerful motivating force for political
and economic progress. It remains to be seen whether the
French and Dutch votes amount to a brief spate of
turbulence, or a major sea change with a potentially deep
impact on the region's prospects.
Setimes 4.07.2005

COOPERATION, COMPROMISE ARE

BACKBONE OF EU ENLARGEMENT
An international rescue effort recently brought to the
surface a seven-man crew of a Russian submarine trapped
under 600 feet of water. A British Royal Navy underwater
robot, the Scorpio Craft, proved essential to untangling a
web of fishing nets and a misplaced antenna. The
endeavour's success was in stark contrast with the Kursk
submarine disaster five years previously, in which all
crewmembers perished amid what many perceived as the
Russian government's reluctance to seek outside help. There
are lessons in this story among other things, lessons about
the importance of co-operation and solidarity.
Britain is also playing a central role in a crisis of a
different sort the turmoil that has come over the EU
following French and Dutch voters' rejection of the
Constitutional Treaty and the subsequent failure, at the June
European Council summit, to agree on a budget for 20072013. These setbacks appeared to expose lingering
79

weaknesses and divisions within the Union. As the current

holder of the EU's presidency, Britain has taken on the
challenging task of helping to steer the Union through a
period of turbulence and self-questioning.
The budget fiasco is a bitter pill for the EU's new
member countries (NMC). Whereas long-standing members
derive only fractions of their national revenues from the EU's
budget, the situation is much different for the NMCs, whose
per capital incomes range between 35 per cent and 70 per
cent of the EU average. EU structural and cohesion funds
can reach up to 4 per cent of their GDP. Some NMCs have
been ready to accept smaller net disbursements of EU funds
in order to lower the Unions budget to 1 per cent of the EU
GDP, rather than the 1.16 percent proposed by European
Council President Jean-Claude Juncker, to no avail. Neither
France nor the UK, the two heavyweights involved in this
"battle", have demurred.
Since Britain is a main contender in the budgetary
debate, perhaps an analogy with the Russian submarine
rescue can provide some inspiration. At a time when the
Union is facing peril, compromise and co-operation will be
vital to mountain a successful "rescue effort".
Unfortunately, the draft EU budget was submitted for
approval before the parties reached agreement on how to
distribute the funds between so called "forward-looking"
support for research and development, structural reforms and
"backward looking" agricultural and regional policy
activities. Further worsening the negotiating climate, the
summit also combined a debate over the Union's Common
Agricultural Policy (CAP) with debate over Britain's rebate.
It is hard to dispute that the CAP needs further reform,
considering the failure of the Doha Trade Negotiations and
the plight of the many poor countries that rely on the export
of farm products. On the other hand, it would be unwise to
80

make EU farm policy dependent on national prerogatives.

EU member countries could end up fighting each other with
subsidies, in spite of competition policy rules, thus further
crippling developing countries interests. Arguably, the
solution is to scale down subsidies to farmers, but in a
socially acceptable way and timeframe and by framing CAP
within overall economic policy. At any rate, a consensus
should not have been out of reach during the Summit, and the
need for CAP reform though real hardly constitutes a
valid reason for derailing the 2007-2013 budget.
The British rebate is a more complex issue. British
pundits and politicians, Tony Blair included, frequently extol
their country's economic success, demonstrated by higher
growth and lower unemployment than in most of the core of
the old EU. They may be overshooting, however, when they
point the finger at an underlying economic model that should
be propagated throughout the Union. After all, the best
economic performance in the EU is on the Scandinavian
fringe, which suggests that the "European social model" can
work when labour market reform and proper research and
development are undertaken properly. And French and
German industrial prowess should not be underestimated.
Certainly, however, the British have a point when they
insist on more workfare as opposed to welfare and on
greater market flexibility. Their success over a period of two
decades, however, undermines the logic of the Rebate, which
was meant to reconcile the low UK per capita income
decades ago with the implications of a weak farm sector. The
UK now has a considerably higher income per capita a fact
which clearly points to a need to reconsider the Rebate.
Finally, what some say about regional policy being a
waste of resources is wrong, both conceptually and
politically. There certainly has been some waste of resources.
But it is hard to deny that the economic development of
81

Spain, Portugal, Greece and Ireland is to some extent also

due to the inflow of EU funds. This flow will be even more
important for most of the NMCs, certainly for Bulgaria and
Romania and eventually for the Western Balkans, which are
less affluent societies with comparatively undeveloped
infrastructure. Politically, it would be more than myopic to
practice arm-twisting within the Union for the sake of
pleasing home constituencies.
The British presidency should convene an
extraordinary meeting of the EU council for the sake of
mending fences and reaching a compromise on the budget.
Politicians now have a chance to show that they can match
the valor of the Royal Navy. For this to happen, however,
there is need to prepare the ground better technically and
show statesmanship at a time of international tension.
Setimes 22.08.2005

LESSONS OF EU ACCESSION
"Enlargement fatigue" in the EU has been a topic of
discussion for some time, even before the proposed
constitutional treaty went down in a stunning defeat in
France and The Netherlands. Some argue that the last wave
of expansion, with ten new members joining overnight, has
already stretched the bloc almost as far as it can currently go
the malaise in some of the bloc's older members, they
argue, signals a need for consolidation. But while a malaise
undoubtedly exists, it could be argued that the fundamental
problems have little to do with enlargement, and to speak of
enlargement fatigue is to misrepresent the basic issue.
82

There are deep currents of change in the world

economy, driven by technological advances and the economic
rise of Asia. These currents have major implications in areas
that resist transformation. Some European heavyweights
show signs of institutional sclerosis. They are unable or
unwilling to make needed adjustments even as the global
economy signals again and again the urgent need to do so.
Thus, feelings of despondency, political impotence and a
growing inclination to blame outsiders arise.
Despite the widespread concern that "something is
rotten in Denmark" in other words, that a need exists for
major structural reforms, as set out by the updated Lisbon
Agenda things are not equally bleak across the Union. In
fact, the record is multicoloured. Some of the northern
countries boast good economic and social performance,
providing policy inspiration for others, while some southern
countries are faring considerably worse. Most of the new
member countries (NMCs) have shown remarkable economic
growth rates in the last few years, an average of over 5 per
cent yearly, more than doubling the average in the old 15
member countries. The Institute for Comparative Economic
Studies of Vienna has projected some degree of economic
slowdown in several NMCs for this year, but the growth
differential between East and West remains large. There is
substantial potential for catching up in the years to come.
In terms of economic growth rates, the Union can be
portrayed by two axes: one that separates the better
performing north from the underperforming south; and
another dividing the stagnating west and the vigorous east.
The latter split has implications for Southeast Europe. The
Union will eventually include the countries located in part of
the continent, and it pays to consider what their forerunners
have witnessed on their way to and after accession.
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Joining the EU has proved an extraordinary anchor for

change, for institutional and structural reform. It has rallied
wide popular support for measures which, otherwise, might
have been very hard to implement. In this respect, we must
not underestimate the importance of keeping hopes alive
during times of economic and social duress affecting more
than a few citizens. Moreover, hope must be sustained after
accession as well, when citizens may become increasingly
disgruntled if growth rates, as translated into personal
incomes, are low. And herein lies a major difference in the
collective psychologies of Eastern Europe compared to parts
of the West. Economic vigour fuels hope in countries aiming
for major improvements, while stagnation breeds frustration.
The growth differential between east and west is
especially significant because post-communist economies are
still plagued by institutional fragility. As economic theory
stipulates, what matters for long-term growth is the quality of
the institutional set-up. On this hinge capital formation,
technological progress, and the building up of human capital
on an adequate scale. Arguably, the efficiency reserves in
transition economies and their capacity to restructure and
absorb new technologies, in spite of inherent institutional
fragility, has defied more sceptical views. This observation,
it goes without saying, is applicable to Southeast European
economies, which benefit from relatively well-qualified
labour and low wages, and whose proximity to western
economies favours substantial industrial relocation.
Two inferences can be drawn. Firstly, economic
growth rates of above 5 per cent annually can be sustained in
the region, aiding the process of catching up. Such rates
would help deal with massive unemployment and its
nefarious economic and social effects. But for such rates to
consolidate, there is a need for intense absorption of new
technologies, for innovation on a broad scale. Such
84

innovation is badly needed so that these economies will not

become over-dependent on low value-added manufacturing
and services.
Related to growth and its prospects is policy
consistency. In spite of vacillations and setbacks, accession
countries have achieved remarkable progress in their
institutional set-ups and the restructuring of their economies.
Arguably, they evince more flexibility in certain respects
than some of their western counterparts. And I am not
referring here to labour markets only. Low inflation is now
ubiquitous, budget consolidation has been advancing steadily
(though the "budgetary shock" of accession is quite
significant, for it demands several percentages of GDP for
the EU budget fee and co-financing of EU funds), and
market regulations have been improving markedly. It is an
open secret that policy consistency is critical for sustainable
growth.
Also important are business-friendly fiscal policies
which stimulate investment and job creation. The
development of small- and medium-sized firms relies on a
congenial fiscal environment as well. There is increasing
fiscal competition in the EU, and no country's policies can
afford to be insensitive to it. For the NMCs, the current
candidates for accession, and Balkan countries looking for
eventual membership, the artistry in fiscal policy lies in
reconciling the need to be more business-friendly with the
needs of raising the resources of public budgets. Higher
budget revenues are called for in order to cope with
functioning inside the EU.
A further factor is one that is too often overlooked in
economic discussions. Recent years have demonstrated the
impact of climate change, with huge floods and dramatic
fluctuations of temperature producing havoc in several
central and eastern European countries in recent years,
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jolting public budgets. I submit that such occurrences are

likely to be repeated, and clairvoyant policymakers have to
make adequate room for contingencies when they allocate
state revenues. This is a challenge for the years to come, in
the sense of not allowing budget deficits to get out of control.
Regional co-operation must also be increased, since natural
disasters do not acknowledge borders. Solidarity is a sign of
policy wisdom and statesmanship.
Last, but not least, the SEE countries need to wage a
more effective fight against corruption, criminality and the
hijacking of the state by vested interests. For sustained
growth to benefit most of the population, as well as for a
strengthened rule of law and a surer democratic
transformation, this demarche is a must.
Setimes 26.09.2005

"ECONOMIC PATRIOTISM" IN THE EU

Well-entrenched cliches are often brought into play
when the EU is being described: single markets, the free
flow of capital and labour, increasingly more uniform pieces
of national legislation, strict anti-trust laws, devolution of
public policy prerogatives to supranational bodies, and so on.
These cliches project the image of a Union in which
corporate identity becomes ever more detached from
member countries, according to the logic of economic
liberalisation. To paraphrase one of Kinichi Ohmae's well
known books, a "Union without borders" epitomises, on a
smaller scale, the borderless world envisaged by advocates
of globalisation.
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One can draw, from the logic of liberalisation inside

the Union, the rhetoric that extols the virtues of "European
champions" companies which operate across European
borders and are capable of being key global competitors.
European Commissioner for Competition Neelie Kroes does
it frequently in the more or less fractious debates she has
with the governments of individual EU member states.
"The borders are gone. It is all about European
champions, and global champions," Kroes said in March.
"When we took the decision to come together in the EU,
when we took the decision to create one internal market, the
national champion [became] outdated."
According to one line of thought in Brussels, the socalled European Champions should underpin the EU's
ambition to become the leading economic player in the world
economy the paramount mission set forth in the Lisbon
Agenda. For several decades now, leading EU member states
have tried to match the prowess of American and Japanese
firms, and the Union's further development has been seen in
this framework. Within the last decade, this rivalry has
acquired an additional dimension owing to the economic rise
of China, India, and other Asian nations.
However, there have been series of recent
developments in the EU which do not fit into the conceptual
framework described above; rather, they clash with the logic
of single markets. For example, the Union's heavyweights
have used a variety of means to maintain the primacy of
domestic capital in banking, public utilities and other sectors
that are judged to have national strategic importance. Thus,
when the Italian group Enel announced its plans to acquire a
majority stake in Gaz de France, the French government
responded swiftly: a merger between Gaz de France (where
the state has a controlling stake) and the private group Suez
was announced.
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In his turn, Romano Prodi retorted that were the Left to

win the national elections in Italy, it would block attempts by
French firms to take over Italian companies. This is the same
Prodi who formerly occupied the post of European
Commission president. The Spanish government, too, has
reacted negatively to the plan of the German group Eon to
take over Endesa, a leading Spanish public utility.
The list of defensive moves goes on. For instance,
several high profile European politicians voiced concern
about Mittal's attempt to acquire a controlling stake in
Arcelor, in the steel industry. Incidentally, Mittal is owned
by a family of Indian origin, though the firm is
headquartered in Europe. Or consider the pharmaceutical
industry, where the French government has backed top
national companies in order to maintain a national flavour. In
Germany, government officials as well as heads of
companies are concocting schemes and "poison pills" for the
sake of fending off hostile takeovers.
What lies behind this apparent resurgence of
protectionism when it comes to leading national companies
in various fields? One explanation would be that
liberalisation (or globalisation), by its very nature, brings
about such reactions throughout the world, in rich economies
as well as poor ones. In addition, the EU is going through a
difficult period, manifested by demographic issues, the crisis
of welfare states, productivity slowdown, and other factors.
In such a climate, "economic patriotism" is a predictable
policy offspring.
The implacable development of single markets entails
defensive reactions one way or another, some would argue.
Because competition produces winners and losers, there may
be an inherent temptation on the part of EU member
governments to support their leading firms.
88

However, there is another way of framing our analysis.

We could also say that the vision of a Union made up of
equal partners (in terms of bargaining power and the ability
to shape formal and informal networks of interaction among
governments and private companies) is far from
corresponding to reality. The "heavyweights" have sought
and will continue to seek ways to uphold their vectors of
economic power and obtain preferential treatment
remember, for instance, how Berlin and Paris got away with
a serious breach of the Financial and Stability Pact rule on
budget deficits. As fondly as we may wish to talk of a
European playing field, the idea of "Europe" remains
something of an abstraction. Given this underlying
nebulousness, it is not surprising that the bloc's leading
players try to keep decision-making centres at home.
One can go further with this logic of power distribution
in the Union. As long as a common foreign and security
policy remains a distant goal, and as long as military
(nuclear) arsenals are not under common (EU/supranational)
control, it is unrealistic to expect that large countries will
nonchalantly allow the takeover (sometimes hostile) of their
top firms by foreign companies, or let major companies go
down the tube we may recall here the controversy around
Alstom and the dim view Paris took of a possible Siemensled rescue operation. Moreover, the fight against terrorism
increases the propensity of national governments to reinforce
their local means of response, which involves locallycontrolled industrial firms.
Another factor relates to a scenario which is seldom
discussed publicly, but is surely on the radar screens of
strategic planners and thinkers. Let's assume that the
economic and political project of the Union, for various
reasons, gets bogged down over time, or becomes
increasingly diluted. In such a case, governments will want
89

to have vectors of economic power under domestic control.

What Commissioner Kroes calls "European champions"
would be an object of competition among major EU member
countries when it comes to controlling stakes and who
should host the headquarters. In brief, the turn towards
protectionism suggests that countries are hedging their bets
when it comes to the long-term prospects for the bloc.
The irony is that protectionist strategies increase the
chances for the Union to see its deepening stalled; it favours
centrifugal forces and the likelihood of sharpened divisions
over all kind of basic policy issues. Such a dynamic does not
bode well for future European enlargement.
Setimes 29.05.2006

LABOR MARKETS AND EFFECTS

OF MIGRATION
Labour markets in the new EU member countries can
puzzle an outsider. Whether the unemployment rate is low
(around 5.5%, as in Romania), or high (above 15%, as in
Poland), sectoral labour shortages are being felt throughout
the economy. And consequences can be quite severe.
How is it that shortages can coexist with surpluses
unemployment so visibly in market economies? A
historical look at the economic policies of transition
economies might help untangle this paradox.
For many years, the rise of wages in transition
economies was influenced by a key provision in the
agreements signed by governments with the IMF.
Specifically, public sector wages were not supposed to grow
by more than a certain rate annually. The rate determined
90

how many people had to be laid off in order to raise salaries

for public sector employees. Clearly, a trade-off was at
work here.
The provision operated also as a benchmark for
collective bargaining sessions between firm owners and
workers in the private sector. The root issues were fear of
large budget deficits and the need to combat inflation and
unsustainable external deficits. In recent years, however, the
situation has evolved markedly.
In Romania, two major features of the economy
explain wage dynamics. One is the share of the private sector
in GDP formation, amounting to over two-thirds. This
presumably diminishes the leverage that public sector pay
has on the functioning of the overall labour market. Now that
Romania has joined the EU, it may be that the dominant
social model in the bloc where trade unions are more
powerful than, say, in the United States will have a strong
influence.
A second feature is massive migration. According to
some estimates, more then two million Romanians work
abroad, mostly in EU member countries. This migration
explains why the unemployment rate is so low in Romania,
even though industrial restructuring is taking its toll. There
are cities and areas in Romania where unemployment is
almost nil, and employers have a very hard time filling
available positions.
Upward pressure on wages is an unavoidable effect of
the steadily falling unemployment rate. Labour shortages are
intense in certain sectors such as construction. Bechtel, a
leading American firm and a major contractor in Romania,
recently complained about such shortages. And this case is
not unique.
The fact that migration reduces the overall
unemployment rate and puts upward pressure on the average
wage level is not surprising. But there's more to the story. In
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transition economies, a phenomenon tends to occur which is,

ironically enough, reminiscent of the command system:
simultaneous shortages and surpluses. A leading Hungarian
economist, Jnos Kornai, wrote a groundbreaking book
explaining how the command system is inherently prone to
this problem, because of its inability to allocate resources
efficiently or achieve price equilibrium in market economies
the coexistence of large shortages and surpluses should not
be the rule of the game; rather, it indicates market rigidity
due to various factor.
One cause, much debated in the literature and verified
in practice, is the capture of jobs by insiders. This causes
some people as the French call them, "les exclus" to
remain outside the labour market circuit. Higher
unemployment can also arise because of powerful shocks,
such as sharp rises in the price of energy. The oil crisis of the
1970s, for instance, engendered "stagflation" in western
economies.
It is noteworthy that surpluses and shortages can coexist at largely different rates of unemployment. Unlike
Romania, Poland has a high unemployment rate. Yet
construction companies in Poland, as in Romania, complain
about the lack of skilled workers. For the period 2007-2013,
the Polish transportation ministry has allocated around $38
billion in the sector. But many worry that the lack of
manpower could severely delay this ambitious construction
programme. This, in turn, would slow down the pace of
modernizing hard infrastructure.
An uninformed observer might see no cause for worry.
In the long run, after all, aren't markets supposed to allocate
resources where they are mostly needed? In fact, the reality
is more complicated. People do not acquire new skills easily
or readily. Even when the market demands such skills, there
can be a lag time before the labour force is able to provide
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them. The difficulty of adjustment is a common denominator

in many transition economies.
Western countries have their own forms of inertia. In
old EU member countries, for instance, the opposition
between insiders and outsiders has prompted an intense
debate. "The global middle asks for reassurance," writes
Harvard economist and former US Treasury Secretary Larry
Summers. He was referring to the anguish experienced by
wage earners in affluent economies under the pressure of
Asian competition. The inference is pretty clear: those who
have jobs will do whatever they can in order to keep them,
even if it impedes the smooth functioning of markets.
In Eastern Europe, upward pressure on wages will
likely continue in the years to come. Indeed, wages may well
grow more rapidly than forecast because of the impact of
intense migration. The rise in wages would be felt in both the
private and public sector too. Should that happen, unintended
negative effects could emerge. Rising wages, if
unaccompanied by adequate productivity gains, will cause
inflation to creep up again and lead to larger, menacing,
external deficits.
Meanwhile, for the first time, Eastern European labour
markets are beginning to exert pressure to admit immigrant
workers. Rising labour scarcity is being seen in various
fields, in conjunction with considerably superior GDP
growth rates (as compared to Old Europe). It is perhaps not
coincidental, then, that Poland and the Baltic countries have
opened their markets to Bulgarian and Romanian workers,
without any restrictions.
19. www.setimes.com-22.01.2007

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PART III
ROMANIAS JOURNEY TO THE EU

ECONOMIC POLICY FOCUS:

TAX REVENUES IN ROMANIA

Romania's economic growth in 2001 was at its highest

level in five years gross domestic product (GDP) jumped
by 5.3 per cent and exports continued to surge. Nevertheless,
imports grew even more rapidly, bringing the current
account deficit to 6 per cent of the GDP. The increase in debt
has been a significant part of the economic picture, forcing
policymakers to turn their attention to financial discipline
and tax collection.
Tax collection has continued to be a challenge to
budget execution, which led to a "sequestration" of capital
expenditure late in the year, in order to meet the budget
deficit target of 3.5 per cent. At a time of swift economic
recovery, fiscal revenues dropped as a share of the GDP,
which is quite unusual. The smaller tax intake can be
explained by the evolution of overall debt, which grew by
almost 5 per cent of the GDP during the same interval.
It also can be attributed to fiscal facilities granted to
small and medium-sized enterprises and state-owned
companies, some of which were privatised last year. There
should, however, have been some offsetting positive
influence of privatisation revenues that, presumably at least,
had entered the public purse. Another factor could have been
the practice of tax deferral for many state-owned and some
private companies.
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The bottom line, however, is that tax collection was

below expectations last year, which has prompted Bucharest
to seek additional ways to raise fiscal revenues in 2002 to try
to keep close to the programmed budget deficit of 3 per cent.
There has been talk, therefore, about increasing excises
for gasoline, alcohol and tobacco, and about eliminating the
VAT exemption for house construction and other endeavors.
One can debate the merits of such proposals for instance,
the adverse effects of raising tobacco excises but the focus
should be on the big question: why did fiscal revenues go
down?
Imagine how much revenue the 19 per cent VAT could
generate against the backdrop of a GDP of about $40 billion,
even after the share for household economy is deducted.
There is a need to mount a joint effort to improve tax
collection, as an optimal means for running a more effective
budget policy.
It is important to better examine the roots of this
situation and determine the best way to tackle it not simply
to apply quick-fixes, which are ineffective over the longer
run. Prime Minister Adrian Nastase's declared intention to
overhaul tax policy and its implementation is a welcomed
effort.
Because of a strained budget, the government is
discussing with the IMF an upwards evision of the budget
deficit for 2002 to 3.2 per cent. A 3 per cent budget deficit
and a higher quasi-fiscal deficit may be worse on the whole
than a 3.2 per cent budget deficit and a decline in the quasifiscal deficit. Care must be taken to avoid unproductive
rigidity in setting policy parameters.
The issue of tax collection is closely linked with the
financial health of major public utilities. The utilities have a
long history of being unable to make good on their financial
claims as a result of fluctuating energy prices, obsolete
98

technology, the impoverishment of a growing part of the

population and a lack of financial discipline. A rise in the
relative price of electricity and heating is not unsubstantiated
economically in view of the procurement cost of raw energy
from abroad.
It is good news to see that the government envisions a
mechanism for distributing the new financial burden over a
longer period of time. Substantial energy savings can also be
achieved by both individual households and industry through
proper measurement of consumption. The longer-term solution to
the public utilities' woes lies in heavy investment in energy
infrastructure, which requires capital and, in this context,
privatisation.
The IMF has said that the privatisation process
proceeded too slowly in Romania in 2001. But privatisation
alone is not the answer: proper structures of corporate
governance matter tremendously, and competition policy and
regulation are essential to achieving good economic
performance. Privatisation in the energy sector needs to be
buttressed by well-balanced contracts.
As the current financial plight of Argentina indicates,
extremely high price of utility services provided, together
with the overvaluation of the local currency, contribute
significantly to the declining loss of competitiveness. In
Hungary, the question of the price of public utility services
has inflamed the relationship between foreign investors and
the government. The pitfalls of deregulation in the energy
markets can suggest how best to proceed with privatisation
in this field.
The Romanian government must impose hard budget
constraints and must foster privatisation to bring in capital.
At the same time, privatisation must be accompanied by a
good regulatory framework in order to adequately deal with
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monopoly behaviour, to secure fair prices for consumers and

to avoid external over-indebtedness.
Setimes 22.03.2002

ROMANIA, THE IMF AND AN EXPECTED

DECISION
I can hardly recall a release of IMF installments to
Romania in the framework of a stand-by agreement that
has stirred less public comment. As a matter of fact, a
favorable IMF decision was widely expected this time, in
spite of protracted discussions and some acrimonious
remarks made, especially, by the Romania side. As currency
market operators would say, the decision was already "priced in".
Although one can have qualms about using a two-yearold structure of household expenditures for measuring
inflation, it is a considerable decline from January to August
2002. In 2002, inflation may even drop a bit below 20 per
cent. Economic recovery has continued and the expected rise
in the GDP is 4.5 per cent for this year. The latter number
hinges, however, on an anticipated favorable impact on
agricultural output after this summer's heavy rainfall. The
budget deficit has been kept under control for the first
seven months it has been 1.4 per cent of the GDP, while the
target is 3 per cent for the entire year and the current
account deficit stays within the territory of safe external
finance.
Clearly, the improvement in the value of the euro has
helped improve the trade imbalance since Romania exports
more then 65 per cent to the EU markets while only 50 per
100

cent of all imports come from those markets. Likewise, the

big increase of private transfers from abroad as Romania
has exported labor massively in recent years has played a
major role in the easy financing of the trade deficit. And last
but not least, the reserves of the National Bank have
continued to rise. Including gold, they are currently above
$6.5 billion, which accounts for about five months of imports.
The improving macroeconomic picture has triggered a
positive response from the rating agencies, which has
preceded the IMF Board's decision. Thus, Romania got a B+
from Fitch, and similar grades were given by other major
agencies. These ratings would lower spreads for Romanian
bonds on international capital markets and ease external
financing of current account deficits. With consistent policies
put in place and further structural reforms Romania could
achieve an investment grade (namely, cross the BBB
threshold) by the end of 2003 or early 2004 and attract more
direct foreign investment.
However, some of themajor weaknesses of the
Romanian economy should keep us pretty alert in the period
to come. The most glaring of these weaknesses is a lack of
financial discipline, which is illustrated by the dynamic of
arrears. Some numbers would suggest that arrears have
grown during 2001 and, in this year, too having gone
above 45 per cent of the GDP. When disinflation is intense
the rise of arrears indicates the diminishing ability of
inefficient companies to use inflation as a way to reduce their
payment obligations in real terms. Should it be the case for a
big number of firms, this could backfire in the not too distant
future.
It may be that the declining interest rates may help
highly indebted enterprises to roll over their obligations at
more favorable payment terms, but the issue remains a
serious one. The situation of public utilities is highly relevant
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in this respect. The balance sheet of energy providers appears

to have been worsening in the last couple of years as they,
unintentionally, took over the role of former state owned
banks in providing "soft" credits to companies. But "soft"
credits are a misnomer, since non-payments are involved.
Burgeoning claims by public utilities on various state
companies, which cannot, or do not pay, produce quasi-fiscal
deficits which, in the end, would burden the public budget
unless dealt with in due course. Unless the issue of the
financial situation of public utilities and of financial
indiscpline is tackled in a determined way it could stifle
future economic growth.
It is fair to say that the rise in efficiency and the
corresponding reduction of costs in the energy sector depend,
frequently, on big investments, and the latter does require the
involvement of foreign capital. But privatisations in this field
should happen against the backdrop of an effective
regulatory framework which should control monopolistic
abuses, protect consumers and avoid excessive external
indebtedness of the country.
For the sake of macroeconomic balance, the Ministry
of Finance has to improve its tax-collection practices,
because raising tax rates (as it did with excises lately) is not
the way to go. Cutting programmed expenditure is not either.
Better tax collection would also help the government in
creating resources for financing the social program, which
was devised to assist low income families following the
dramatic rise in the price of energy; better tax collection has
to go hand in hand with fiscal reform measures.
The government needs also to control better wages in
the public utilities. In general, wage dynamics have to be
linked with productivity gains.
As to monetary and exchange rate policy, the National
Bank would be well advised not to let the Romanian Lei
appreciate too much in real terms unless productivity gains
102

are substantial; the Euro's real appreciation vis--vis the US

dollar cannot go on indefinitely and speculative capital
inflows should be discouraged. The National Bank should
also monitor closely the short term borrowing of commercial
banks from abroad.
Caution, prudence and consistent policies are
demanded from the government and the National Bank in
view of the increasingly complicated and uncertain
international environment, and persistent economic gloom in
the EU and the US. The goals of economic policy for 2003
should consider these circumstances as well and prepare
contingency measures.
Setimes 14.10.2002

RUSHING INTO THE CAPITAL ACCOUNTS

IS RISKY
The EU requires all candidates to open their capital
accounts (KAL) by the time of accession, but makes no
specific demands on speed or procedures to pursue. In 2001,
Romania unilaterally committed itself to liberalising
movements of capital by 2004 well in advance of its
prospective date of accession. There are only two exceptions:
one regarding specific money market instruments and another
concerning inward land purchasing by foreigners. While the
effort to catch up with other candidate countries is quite
laudable, the KAL decision calls for serious examination in
view of its possible, less benign consequences.
Following the series of wild financial and currency
crises worldwide during the last decade, a wide consensus
has developed among economists that full opening of the
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capital account should not be hastened prematurely in

emerging economies. Basic prerequisites for full
liberalisation of capital transactions are the existence of a
solid growth-supporting macroeconomic framework, the
elimination of major structural imbalances and a healthy and
well-tested operational and regulatory framework for the
financial system.
Romania has improved its economic performance
considerably in the last couple of years and a series of
indicators look quite good. The overall public debt is fairly
low (under 30 per cent of GDP); the domestic public debt is
only 8 per cent of GDP and its financing is accomplished
increasingly with longer maturities and at lower interest
rates. The external indebtedness of the country is low (below
30 per cent of GDP); the reserves of the Central Bank (NBR)
amount to circa 5 months of imports. The share of external
short term finance of public external debt is low. On these
grounds, one might try to justify the decision to open the
capital account at a swift pace.
But Romania still has important vulnerabilities, a fact
which should make public authorities more cautious and lead
them to re-examine the current sequencing of KAL.Inflation
is still high; there is a very low level of monetisation and
financial intermediation, which makes wide swings of capital
flows highly disturbing and sterilisation operations (by the
NBR) costly; there is insufficient restructuring in the real
sector and poor governance at the enterprise level, creating
inflationary pressures and straining the public budget. Law
enforcement in the financial sector remains weak and the
new prudential rules are still to be tested; bank profitability
and efficiency are low. Therefore, one can imagine a
scenario of rises in the prices of domestic assets, following
substantial speculative capital inflows (stimulated by the
Leu's real appreciation), which may create instability.
Reckless internal and external over-indebtedness of local
104

firms and municipalities may also ensue, which would be

quite threatening in view of the still soft budget constraints
operating in Romania; the trade deficit may grow again
sharply, abetted also by the real appreciation of the Leu,
while it is not solidly proven that private transfers from
abroad would not stop growing, or even decline, as a
consequence of possible international adverse events.
There is another issue that should concern policymakers.
Full KAL cripples the ability of public authorities to conduct
an autonomous monetary policy while they try to achieve
some stability of the exchange rate. In the latter case, the
burden of macroeconomic adjustment falls overwhelmingly
on budget policy, and a deflationary bias may very likely be
imparted to its stance.
What is happening currently in the EU with several
of the leading countries being at great pains in meeting the
demands of the Stability Pact (in terms of budget deficits)
should be a stern warning in this regard. In order to restore
some autonomy to monetary policy, a free floating of the
exchange rate would have to be practised, but this in itself
could be highly destabilising and require an extremely
restrictive monetary policy (following sharp depreciation of
the exchange rate).
Is the Romanian economy ready to accept the
consequences of full KAL from this perspective, one
involving a much diminished room of maneuver for
macroeconomic policy? This question gains an even higher
profile by judging the likely time of Romania's accession
into the EU. This is why the "look good" indicators and the
confidence some entrust in the ability of Romania to rely
increasingly on remittances from abroad and revenues from
tourism do not warrant complacency; the latter is equally
hindered by the 2007 time target for EU accession. One
should also keep in mind the balance of payments crisis the
105

Czech Republic went into after opening the capital account,

or the mounting fiscal difficulties it is currently experiencing
along with Hungary and Poland.
Arguably, policy-makers would be well advised to reexamine, in practical terms, the current KAL program by
considering the need to make an effective preference for long
term flows against short term flows (the liberalisation of
short term flows should be accompanied by adequate prudential
measures); the need to make an effective preference for
capital inflows against capital outflows; and the need to
avoid an undifferentiated and complete liberalisation of
capital inflows. Likewise, more attention should be given to
the principle of contingency: actual liberalisation should
proceed only when only well-defined macroeconomic and
structural conditions and criteria are fulfilled.
There are number of concrete measures to "shape" the
composition of flows which policy-makers might consider.
Unremunerated reserve requirements could be imposed for
short term investment or credit taken in foreign currency.
The NBR could practice a system of discriminatory reserve
requirements on foreign exchange deposits of banks.
Restrictions could be placed on corporate and public sector
short term credits from abroad. Banks could be prohibited
from using short term debt instruments as collateral for
borrowing in foreign exchange abroad. Support could be
given to the creation of an independent rating agency for
Romanian corporate and municipalities' debt instruments.
Purchase abroad of bonds, shares and other securities could
remain subject to authorisation by the competent supervisory
body.
Since the EU does not impose a timetable on Romania
for full opening of the capital account, a readjustment of the
programme can be made. It would also be wise for the
government and the NBR to consult with experts from IFIs,
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such as the IMF and the World Bank, for this is a matter of
utmost importance for the economy.
Setimes 3.03.2003

DOES ROMANIA HAVE A FUNCTIONING

MARKET ECONOMY?
The European Commission (EC) asks countries
aspiring to EU accession to comply with two fundamental
requirements: to have a "functioning market economy" and
to withstand competitive pressures in the Union. The second
demand recognises the dramatic reduction in scope of
national economic policy in an area which practices a
common monetary policy, and in which intra-trade barriers
no longer exist. Twelve EU member countries share a single
currency; in a softer form, the ERM2 constrains exchange
rate policy in the remaining states. Both demands are seen as
essential for enhancing nominal and real convergence,
without which the Union would be undermined from within.
The transition countries which are to be admitted in
2004 were granted functioning market economy status a
while ago. Bulgaria, too, received it last year. The
neighbouring country's economic upgrade, along with the
debate over Turkey and other would-be accession countries,
has raised the stakes for Romania, in a race which has
become increasingly challenging in view of the economic
and geopolitical circumstances which accompany enlargement.
Do basic market institutions exist in Romania, and do
free prices, for the most part, allocate resources? Clearly,
they do; Romania has a functioning market economy. But
major weaknesses are present, including lack of financial
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discipline, insufficient enforcement of market regulations,

low transparency and stability of the regulatory framework,
inefficient public administration, an unsatisfactory judiciary,
and so on. Thus Romania still has quite a way to go in order
to become a highly performing market economy. Could the
status of the country's economy be changed by the end of
this year?
Some economic evidence suggests that it could.
Recovery continues; the GDP grew by 5.7 per cent and
4.9 per cent in 2001 and 2002, respectively. It will probably
slow down to about 4 per cent this year, primarily because of
economic stagnation in the West and a bad domestic harvest.
Inflation, the scourge of the past decade, is coming down
decisively. From 30.3 per cent in 2001, it decreased to
17.8 per cent in 2002 and will most likely fall to around 13
per cent this year. The banking system is much sounder now,
following a massive clean-up operation, and its reserves have
jumped remarkably in recent years. Overall public
indebtedness is below 30 per cent of GDP, out of which the
external public (and publicly guaranteed) debt is about
75 per cent, while short term indebtedness is relatively low.
Budget deficits have been kept under 3 per cent in the last
couple of years and current account deficits have been, on
average, around 5 per cent.
This state of affairs has not gone unnoticed by the
major rating agencies, which increased Romania's standing
from B- to BB-. This is still below investment grade, but
prospects for further positive revisions are deemed fairly
high. The improved economic picture has emboldened top
Romanian officials, who expect a positive judgment from the
Commission in next November's report.
Other arguments can be used in Romania's favour as
well. Some countries have registered sharply deteriorating
economic indicators (budget and current account deficits)
well ahead of their accession in 2004, while Romania's
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economic performance during the same period has improved

quite visibly. Furthermore, when long-standing members of
the EU have had a difficult time meeting some of the
Maastricht criteria, does it make sense to be overly strict
with Romania? Of course, one can reverse the logic of that
question: if well-functioning market economies can have
such a hard time inside the Union, how would less wellfunctioning ones fare after joining the Club? The answer
depends on examining other basic issues such as ability to
give up the autonomy of policymaking (as a shock-absorber
device) to the degree implied by accession. Are the
Maastricht criteria in need of amendment, so that policy
responses can be enhanced in times of duress? These issues
concern the EU members and aspirant countries equally.
There are also factors which weaken Romania's
credentials for receiving an upgrade. Hard budget constraints
do not yet operate ubiquitously, and large loss-making
companies produce sizeable quasi-fiscal deficits, especially
in the energy sector. There is a deepening crisis in the
pension system; domestic investment is too low to support
long-term growth; the agricultural dossier is burdensome and
worries our EU partners; and public administration is in need
of major reform. Most of these problems cannot be dealt
with rapidly, since they have a structural nature. Some of
them, however, do not pertain to Romania only; they have a
high profile in other accession countries as well. Moreover,
the crisis of pension systems has been a problem for the
existing EU members as well.
The bottom line is that a change in status makes sense
if double standards are to be avoided and genuine economic
progress acknowledged. At the same time, the Commission
should also reiterate that Romania's economy has major
specific weaknesses; that 2007 represents a timetable for
admission and not a firm decision of the EU; that the period
prior to admission allows Romanian authorities leeway for
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effective autonomous economic policy-making, which

should be used (and not abused!) in order to combat the
country's economic vulnerabilities; and that populism should
not lead economic policy astray during the upcoming
election year. Brussels has powerful incentives in its
dialogue with the Romanian government. For instance,
Romania can benefit on financial assistance amounting to
circa 1 billion euros per year, provided economic and
institutional progress continues at a steady pace.
It would be highly disappointing for most Romanian
constituencies if the EC were to decide to wait for further
signs of economic and institutional improvement in order to
upgrade the country's status. Nevertheless, we should
remember that we institute reforms primarily for ourselves,
and that whatever decision is made in November, no solid
guarantee exists that Romania will join the EU in 2007
unless structural weaknesses are addressed with a strong
commitment and results of improvement (which involve the
assimilation of the acquis) multiply in a convincing manner.
Romania needs a considerably better-functioning market
economy in order to join the EU successfully.
Setimes 25.08.2003

EU ACCESSION ROADMAPS COULD CAUSE

SOME BUMPS
At the last EU summit in Copenhagen, Bulgaria and
Romania received roadmaps which act as yardsticks of
reforms needed for EU accession. Although the roadmaps
are fairly eloquent, they leave a number of questions
unanswered.
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The adoption of the acquis communautaire (the set of

EU norms and regulations) is only partially a technical
operation of transposing the EU rules into national
legislation. In a deeper sense, the assimilation of the acquis
concerns the actual functioning of local institutions as a
precondition of economic and social performance. For this
reason, the European Commission has underscored the need
for reform of public administration and justice and for
continuing the fight against entrenched corruption.
Arguably, the reforms that are being requested by the
EU are more demanding than the creation of a
"conventional" market economy together with a liberal
democracy. This is because the EU is the fruit of organic
development and also of meticulously engineered
institutional construction. The latter, in particular, is meant to
bring national contexts of relatively close economic
development levels nearer institutionally and functionally.
Accession demands a series of institutional adaptations,
which otherwise would not be asked for.
In spite of lingering economic discrepancies, the EU is
made up of prosperous economies and societies. Therefore,
Bulgaria and Romania are confronted with a major
developmental handicap, which cannot be done away with
quickly. The income per capita in Bulgaria and Romania is
below 28 per cent of the average in the EU in Purchasing
Power Parity terms.
At the same time, the Maastricht criteria, which
concern the level of inflation, interest rate differentials,
budget deficit limits, and limits of variation of the exchange
rate, are not easy to fulfil and may constrain economic
growth. The autonomy of economic policy would be
severely constrained even during the pre-accession period
and may reduce considerably the capacity to deal with
adverse shocks.
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The "political economy" of enlargement is also an

issue to consider. The first wave of enlargement in 2004 can
be taken for granted; further accession waves are far from
being a certainty. Future enlargement depends on the internal
metabolism of the EU, which could be severely tested by
rising divergence of economic performance, due to mounting
economic difficulties all over the EU in recent years, and by
the formation of various "coalitions", with different views on
the nature of deepening and the management of EU internal
issues as well as the formulation of a common security and
foreign policy.
A main inference is that the assimilation of the acquis
implies both benefits and costs, and the latter are not to be
underestimated. Moreover, costs are not easy to illustrate and
measure, and that could create a credibility problem for
public authorities should these costs be revealed as
substantially higher than anticipated.
Admittedly, benefits would go far beyond costs. The
accession negotiations would discipline policy making; EU
accession related reforms would become more consistent and
steady. Against the background of assimilating the acquis,
the link with the EU looks far richer than that with the
international financial institutions. The EU could provide a
push in order to overcome a developmental and
modernisation challenge. Aside from the benefits brought
about by institutional reforms, financial assistance can make
a huge difference, if it is used wisely. The EU can also
provide an economic "shelter" at a time when uncertainties
and vagaries multiply in the world.
But there is a series of aspects that the roadmap leaves
open:
There are policy issues which do not have clear-cut
solutions and multiple policy options are available; choices
should try to optimise according to domestic circumstances
and most likely external conditions.
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Policy needs to observe the ABCs of sound economics

(achieving low inflation, keeping fiscal balance over the
business cycle, making hard budget constraints operate
ubiquitously, etc.) but be pragmatic at the same time; it is
inimical to succumb to theoretical fundamentalism when it
comes to real life. For example, markets should be regulated
effectively.
Policy needs to avoid hasty decisions, which may score
"prestige points" but are likely to be quite costly unless
addressed properly. One example would be a hasty full
liberalisation of the capital account.
The fate of national industry depends on how domestic
sectors enter main European industrial networks. Public
authorities can play a role by using various policy tools
(including tax incentives and a better business milieu for
inward investment in industry). This assertion does not imply
continuing to subsidise heavy loss makers and denting the
profitability of successful companies.
Infrastructure needs a lot of improvement. To this end,
funds from the EU and from other specialised institutions
the European Investment Bank, in particular have a key
role to play. The experience of Portugal, Spain and Greece
shows what tremendous progress can be made by making
good use of EU structural funds.
More resources have to be assigned, via the public
budget, to education and health care services. This issue will
be increasingly challenging in the years ahead. As in the case
of infrastructure, a better performing economy and better tax
collection would allow significant improvements.
Agriculture will, very likely, be a major stumbling
block in accession negotiations, for it holds a relatively large
share of the GDP and keeps much of the active population
busy. One should also consider the heavy subsidisation of
this sector in the EU.
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The purely economic problem could be compounded

by farm land consolidation, which would likely force
younger people to try to find jobs in the urban areas. This
might recreate the old "rural overpopulation problem" if
other sectors do not provide a sufficient number of jobs. In
view of the demographic ageing in Europe and the increasing
propensity (because of wage differentials) of Bulgarians and
Romanians to work abroad, the export of labor may offer a
venue for alleviating or averting a major social crisis. Both
countries need to avoid a Latin American-type evolution in
this regard, and proper agreements with the EU would be a
means of tackling the issue. In fact, a "Grand Bargain" may
be in the offing. Transition economies would supply labor to
the EU, making it possible for citizens who work abroad to
send substantial amounts of money back home; and these
private transfers would make up a sui generis safety net.
Setimes 21.04.2003

ROMANIA'S ECONOMIC POLICY

CHALLENGES IN 2004
Romania finished 2003 with a positive, but not
unblemished, macroeconomic record. The country saw
economic growth of around 4.7 per cent. Inflation is down to
14.1 per cent. The budget execution seems to have ended
with a deficit of 2.3 per cent, and Central Bank reserves have
grown marginally to just below 8 billion euros. Inward
Foreign Direct Investment (FDI) also has risen to more than
1 billion euros, though not in a spectacular fashion. These
results were accompanied by upgrades from the main rating
agencies, although Romania still is several notches below
investment grade.
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Spoiling the picture, however, is the surge in the

current account deficit, estimated to have reached about 6.5
per cent of the GDP which is about 3 per cent more than in
the previous year. In addition, tensions related to insufficient
industrial restructuring have continued, and may have
contributed to the rise of the trade deficit. An illustration of
these tensions is the persistence of large arrears in the
economy.
The economic year 2004 is important in and of itself,
and also in terms of the direction the Romanian economy is
taking with the aim of joining the EU in 2007. Disinflation is
getting to a critical stage; further advances hinge essentially
on fiscal and financial discipline, which in turn depend on
the restructuring of several key industrial sectors such as
energy generation and distribution.
What are the driving factors behind the rise of the
current account deficit in 2003? A macroeconomic
explanation would focus on last year's economic growth.
Unlike previous years, growth during 2003 was fuelled by
internal demand rather than exports. Other causes can be
found in the financial lack of discipline and inefficiency in
the economy, heavy dependency of exports on intermediate
imports and the worsening terms of trade for the Romanian
economy. Oil has been more expensive. The severe drought
entailed additional imports of grains and foodstuffs. Other
factors include a low ability to produce domestic products;
the real exchange rate appreciation of the domestic currency;
and the euro's appreciation against the US dollar which has
made imports from the dollar zone extremely attractive. At
the same time, the general subsidy given to exporters in 2000
has undergone diminution. Consumer credit, too, has played
a role.
The government's assumed main policy targets for
2004 include bringing inflation down to 9 per cent; a 5.5 per
cent GDP growth rate; and a reduction of the current account
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deficit to 5.8 per cent of GDP although that figure is still

being discussed with IMF experts. The possibility of
achieving these targets has to be evaluated in relation to
election year pressures, the rise in the current account deficit
and structural constraints. Prominent among the latter are
quasi-fiscal deficits, which can burden the budget severely
unless dealt with in due course. On the other hand, the goal
of concluding negotiations with the EU this year could
provide a strong policy anchor.
Two aspects of the policy targets stand out. One is the
highly ambitious disinflation rate from 14.1 per cent to 9
per cent. The second is a looming conflict between the
economic growth target and the need to control the current
account deficit.
The challenge of bringing down inflation to a singledigit level should be examined in the context of an
insufficient restructuring of the economy and the existence of
arrears. Hard budget constraints do not operate ubiquitously,
and loss-making companies produce sizeable arrears and
quasi-fiscal deficits. High inflation has been used by many
companies as a means to stabilise arrears in real terms and
thereby survive. Current disinflation strains loss-making
firms. Unless restructuring makes considerable headway,
persistent large quasi-fiscal deficits will clobber the budget
and the economy in the future. Disinflation will stalemate at
some point unless hard budget constraints operate
unabatedly.
It could also be argued that the projected pace of
disinflation clashes with the economic growth objective,
given the surge in the current account deficit. One can
imagine a scenario in which the growth target would be least
impaired by trying to stick to this year's current account
deficit, in the hope that larger inward FDI and portfolio
inflows would make financing relatively easy. The desire to
maintain the economic growth objective of 5.5 per cent looks
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quite attractive in relation to expected pressures during an

election year. But this policy mix would jeopardise the
macroeconomic balance by betting on highly variable
factors.
Bringing inflation down to a single-digit level and
reducing the current account deficit by a substantial margin
0.7 per cent to 0.8 per cent of GDP requires containing
domestic demand firmly. If other conditions remain
unchanged, that would unavoidably bear on the GDP
dynamic. Certainly, one needs to factor in the effects of the
electoral year, which may cause policy slippages.
There are premises for limiting collateral damage
resulting from populist measures, owing to the EU anchor
Romania wishes to conclude as many negotiating chapters as
possible this year. If policy slippages stay small, a singledigit inflation rate could be achieved with a current account
deficit below 6 per cent of GDP. By contrast, a primary
focus on growth would harm the other goals. A policy mix,
which aims at optimising under constraints, would have to
include prudent liberalisation of the capital account.
Setimes 16.02.2004

FOR ROMANIA AND BULGARIA,

ABSORPTION CAPACITY IS ESSENTIAL
A recent budget decision may prove to be a basis for
the European Commission (EC) to develop common EU
positions this spring so negotiations can proceed on the
chapters in the accession talks that have financial
implications. The decision was accepted by the EU on 22
March and if Bulgaria and Romania join the Union in 2007
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 the two countries will receive almost 15 billion euros for

effective spending between 2007 and 2009.
The decision was welcomed in Sofia and Bucharest,
since it is regarded as a signal that the two countries are next
in line for accession following this year's EU enlargement.
The move indicates that budgeting is being done in light of a
strategic decision and a corresponding timetable.
The budget proposal, however, comes at a complicated
and momentous time in the history of the Union. Many
wonder how enlargement can be combined with a genuine
deepening. Managing the increasing complexity of the
enlarged Union is perceived as a formidable challenge for
the years to come. There is rising concern about the EU's
apparent lag behind the United States and some Asian
economies in terms of competitiveness and the use of
information and communication technologies.
Some, particularly in the donor countries, thus argue
that the EC is doing things backwards. The budget, they say,
should place more emphasis on funding research and
development activities, which would underpin knowledgebased sectors and bolster the Union's ability to compete in
world markets.
Barring increases in the Union's budget, the debate
inevitably pits donor countries against recipient countries.
The outcome of the debate has special significance for the
new member countries, which would become the largest
recipient areas for financial assistance. For some of these
countries Poland and Romania, for example large-sized
rural sectors complicate matters even further, due to the
challenge of reforming the Common Agricultural Policy.
Enlargement fatigue along with constitutional disputes
institutionally bogged-down reforms and economic pains
within the Union and have raised the stakes for Bulgaria's
and Romania's accession in 2007. The issue of how these
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two countries use EU funding is receiving considerably more

attention than in the case of the countries which are joining
the Union this year.
EU funding is already available to candidate countries.
How this funding is used before and after accession is of
enormous significance. EU financial assistance can
supplement national budgets during periods of severe
retrenchment, and when the output of public goods health
care, education, repair and construction of infrastructure is
under pressure. Moreover, EU assistance can target the
development of local institutions, which underpin economic
performance.
The way a candidate country uses financial assistance
is indicative of its ability to develop economically and to
catch up with the EU member countries. Bulgaria and Romania's
relatively low absorption capacity shows that both countries
are attracting considerably less Foreign Direct Investment
than they need.
Another way of looking at absorption capacity, which
relates it to how EU members view a candidate country, is
that low absorption capacity can dent a country's credentials
for membership if some inside the Union see it as a
reflection of inadequate economic and institutional
prerequisites for accession. For this reason, using financial
assistance as efficiently as possible has additional
importance and should be a top policy priority in a candidate
country.
However, the ability to use financial assistance is no
less important following accession. New member countries
must contribute significant amounts to the EU budget.
Romania, for instance, would have to pay an annual amount
of about 800m euros upon accession. Complying with the
requirements of the acquis communautaire will be quite
costly, as would be observing EU regulations in the area of
environmental protection.
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A low absorption capacity could, paradoxically, turn a

new member country into a de facto net donor. Policymakers
in the new member countries, and in Bulgaria and Romania,
need to think seriously about how to increase the capacity to
absorb financial assistance. Such absorption must be judged
not only in pure technical terms as an absorption
coefficient, which should be as high as possible but as a
means to foster overall economic development.
The race to join the EU is becoming tougher for
Bulgaria and Romania, and making the best possible use of
EU funding is of enormous importance. Reforms are crucial
they condition the capacity to absorb funds. Funds, when
used skilfully, support reforms. Clear rules of the game,
transparency, and an emphasis on projects of high public
utility are likely to trigger a chain of positive effects
throughout the economic body of the country and to
strengthen the fight against corruption. Such an approach
should shape the agenda of policymakers. What happens
with Bulgaria and Romania will provide a major lesson for
the whole of Southeast Europe.
Setimes 5.04.2004

REVENUES AND THE FLAT TAX IN LIGHT

OF ROMANIAS EU ACCESSION
The presidential and legislative elections of November
2004 resulted in a major political shift in Romania. The new
government introduced a radical fiscal reform which relies
on a flat tax of 16 per cent on incomes and profits. The
reform is best viewed within the wider context of fiscal
competition across Europe wealthy and less wealthy
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countries alike are attempting to lure more inward

investment at a time when competitiveness challenges are
multiplying. Hungary and Poland have led the way in recent
years, with the latter country keeping the experience of
Slovakia in mind contemplating a flat tax. Older EU
members have not been insensitive to these measures.
Austria has already lowered corporate taxes, and German
Chancellor Gerhard Schroeder recently announced plans to do so.
Although the rationale for lower taxes is transparent,
the timing of the Romanian government's move has raised
questions. The economy has been growing rapidly in recent
years, at an average rate of 6 per cent of GDP over the last
four years, and more than 8 per cent in 2004. At the same
time, external deficits have been on a steady and rapid rise.
This context is what lies behind the difficult dialogue
Bucharest has been conducting with IMF experts in recent
months. The Fund is concerned that budget revenues could
be adversely affected by the flat tax in an economy that they
view as "overheating".
However, the Romanian flat tax has to be judged in the
wider context of Romania's planned entry into the EU in
2007. The country signed its accession treaty on 25 April,
but its social and economic performance must bolster its
reform efforts in order to avoid having its entry delayed by
one year, as provided for by the so-called "safeguard" clause.
In the interim, Romania will continue to come under pressure
to make its economy more market-oriented.
In fact, the overall picture has been improving
substantially. Inflation is at a one digit level for the first time
in 15 years, the banking system is on a solid footing, the
reserves of the National Bank cover more then six months of
imports, and exports have been rising vigorously. But fragile
areas in the economy remain, and specific changes, such as
full liberalisation of the capital account, are demanded by the
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acquis communautaire. This, along with tax reform and a

number of other institutional shocks freer floating of the
Lei (ROL), administered price and tariff rises, the
introduction of the hard ROL, the shifting to direct inflation
targeting, a new labour code, and the requirements of the EU
competition policy will test the economy's capacity to
adjust smoothly.
The new measures are likely to reveal significant
rigidities, which will necessitate adjustments. The National
Bank, by maintaining a range of 3 per cent around the annual
inflation target of 7 per cent, speaks implicitly about the
possibility of an inflation slippage, which could occur at an
ill-suited time, in view of the introduction of a monetary
policy regime that focuses clearly on inflation.
Data regarding the commercial deficit over the first
two months of the year point to the continued growth trend:
it is approximately 80 per cent higher compared to the same
period in 2004. The current account deficit has also
continued to grow at a fast pace, with the non-governmental
credit setting the pace. On 1 April, a wave of price and tariff
rises began, impacting the dynamics of inflation. The
progress of disinflation depends not only on the
reverberations of these rises throughout the economy, but
also on their impact on inflationary expectations.
The macroeconomic situation sketched above shows
why the discussion regarding possible policy slippages is not
a mere intellectual exercise. The growth of the economy, the
expansion of the non-governmental credit and the
appreciation of the ROL lead to larger external deficits. The
appreciation of the ROL is helpful for disinflation, but to
what extent remains to be seen hence the concern regarding
the "overheating" of the economy. Should slippages occur
this year, however, they should not be dramatised. It is not
the budget deficit which is to blame for the rise of the current
account deficit; the main driving engine, by far, is private
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sector borrowing, which accounts for about 85 per cent of

the figure. Squeezing the public budget for the sake of
limiting external deficits will be of little help.
As the time horizon is extended, the situation becomes
more complex. Romania's prolonged dialogue with IMF
experts does not centre on this year's numbers, but on the
broader perspective, and specifically on the emergence of
pressures unrelated to tax reform on the public budget.
EU accession involves substantial expenditures, including
the contribution to the community budget (about 1.3 per cent
of GDP) and the co-financing of structural funds (over 1 per
cent of GDP). Together with social security reform and the
need to supplement the funds allotted for education and
health, budget expenditures will grow by at least 3 per cent
to 4 per cent annually. Without a better collection of budget
revenues, and assuming other conditions remain unchanged,
the deficit of the consolidated public budget would reach 4
per cent to 5 per cent of GDP in a few years' time.
The ever-decreasing budget deficits of the last few
years have been hiding an important structural problem,
arising from two factors. One is the impossibility of
repressing expenditures if Romania is to provide a volume of
public goods appropriate for an EU member country. The
second is that EU accession brings with it requirements for
competitiveness and modernisation.
As a new member, Romania will be joining several
neighbours which have accumulated high budget deficits due
to accession costs. But the situation in the Czech Republic,
Hungary and Poland differs significantly from that of
Romania. In those countries, budget revenues are larger by a
few GDP percentage points, making it easier to enact painful
adjustments on the expenditure side of the budget in case
these cuts are needed. Moreover, in these countries the "twin
deficits" logic is operative, with external deficits co-existing
with considerable budget deficits thus, a major decrease of
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the budget deficit would likely lead to an appropriate fall of

the current account deficit, were a balance of payments
adjustment badly needed.
In Romania, the falling budget deficits of the last few
years have cohabitated with swiftly growing current account
deficits. Should the budget deficit grow significantly in the
years to come, without a reduction in the private sector's
appetite for consumption and borrowing, the current account
deficit could easily reach over 10 per cent of GDP. Such a
level would be worrisome to the extent to which it would
involve funding from short term loans and inflows of
speculative capital. A massive depreciation of the ROL could
then be expected, which in turn would reignite inflation and
possibly lead to readjustment of the public budget.
Should EU accession bring about a dramatic
improvement in Romanias economic and social performance,
the concerns described above will be largely alleviated. More
modest improvements could, at the very least, help the
country deal with future budgetary issues. It would be
unrealistic to expect these issues to disappear miraculously.
Romania cannot afford to ignore them during its dialogue
with the IMF.
Setimes 2.05.2005

ROMANIA AND THE LISBON AGENDA

A third independent report assessing Romania's
economic performance in terms of the Lisbon Agenda
benchmarks was recently released. It follows up on a
November 2004 study, which focused on competitiveness
and ways of increasing convergence with EU standards, and
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an initial analysis in March 2004, which featured a scorecard

based on the main objectives set out in the Agenda.
The new report has been undertaken against the
background of the revised Agenda; it uses structural
indicators in order to assess the Romanian economy
comparatively and examines the linkage between policies and
the economic recovery/growth of recent years, the challenge
of competitiveness in the local context, and the ability of
Romanian policy-makers to foster job creation as a means to
mitigate migration.
Broadly speaking, the Lisbon Agenda is an ambitious
policy programme meant to combat the low productivity and
economic stagnation witnessed in the EU, which has found
itself lagging behind the United States and, increasingly,
emerging Asian economies. The stated goal is to turn the EU
into "the world's most dynamic and competitive economy"
by 2010. The programme places a special emphasis on
building an information society through computer literacy,
technological innovation, and the development of IT-related
businesses.
The Lisbon Agenda functions both as an overarching
vision and a complex set of policy guidelines. Its priorities
can be interpreted by EU member and accession countries
differently, national performances and circumstances vary
significantly. While the older EU member states are
especially focused on job creation and support for R&D as
well as reform of the welfare state, for a candidate country
like Romania the main priorities are economic restructuring
and improvement of the business environment. Although
information and communication technologies can sometimes
work wonders, development stages cannot simply be leapt
over at will. For Romania and other nations in transition,
technology absorption will remain essential the foreseeable
future.
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Embarking on the grand aims set out in the Lisbon

agenda may seem a luxury for Romania's emerging
economy. Such economies, as is commonly known, rely
mainly on the absorption of available modern technologies in
their quest to achieve rapid economic growth. Although
substantial economic progress has been achieved in recent
years (prompting Fitch and S&P to give Romania its first
investment grade ever) the structural foundations of the
Romanian economy are not sufficiently strong. Moreover,
the local financial intermediation is inadequately developed,
agriculture remains behind the times, and external deficits
have been growing sharply. Under these circumstances,
moving towards a knowledge-based economy is a pretty
daring endeavour.
In fact, Romania has a long way to go to reach the
goals set forth in the Lisbon Agenda. Although progress has
been made, it is not even close to approximating the 25
current EU members' performances in most areas. In no
small part, this is because Romania has different priorities
and challenges.
The good news is that knowledge diffusion that is,
the spread of an information technology is advancing at a
good pace, although knowledge creation indicators are still
underperforming. The emergence of software firms signals
there is movement in the right direction. The key to longer
term growth, however, is the production of higher valueadded products and services, and this will require a sustained
focus on education, the building up of skills, and expansion
of technological knowhow keeping up with the latest
information and communication technologies.
The new report includes a number of policy
recommendations for boosting Romania's progress towards
the Lisbon goals. Of the greatest urgency is strengthening the
country's capacity to absorb EU funds; one way would be
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through establishing a special vehicle, such as a Corporation

for Infrastructure Development. Public expenditure should
be overhauled, redirecting funds towards areas that
strengthen the country's human capital infrastructure and
administrative capacity. Multi-annual budget programming is
a must.
Certainly the road to a knowledge society will not be
easy unless the current decline in R&D spending is reversed.
The report advocates directing more state aid towards R&D
objectives and providing support for businesses to conduct
R&D. For example, fiscal incentives could be linked to the
share of R&D expenditures in turnover or the share of R&D
employees in total employees, or the number of patents
registered each year.
Specific Lisbon-related goals also have to be seen
within the context of larger policy problems affecting the
entire economy. For example, Romania needs a vigorous
competition policy to prevent market abuse. The tax base
should be broadened and tax collection improved in order to
avoid "budget shock" at the time of EU entry. Excessive
appreciation of the domestic currency should be prevented
through direct inflation targeting. Non-wage components for
labour costs should be reduced, especially for low-skill jobs,
hiring and firing costs should be reduced, and the Labour
Code further improved. Lifelong learning should be
encouraged.
Romania's performance should be judged realistically.
It will be some time before the country is genuinely in a
position to embark on creating a fully-fledged "knowledge
economy" or tackle the other long-term Lisbon goals.
Nevertheless, the effort needs to be undertaken, though in a
form that fits the specifics of the Romanian economy. The
reasons are clear. Firstly, the Lisbon Agenda ranks very high
on the list of priorities of the club which Romania will soon
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join, the EU. Secondly, working towards the long-term

vision will spur the country to make needed upgrades to
products and services, in turn facilitating growth in all areas.
The seeds of change have to be sown starting now.
Setimes 7.11.2005

THE ROMANIAN ECONOMY:

WHAT TO WATCH FOR IN 2006
Forecasting Romania's economic performance in 2006
is a risky business. However, we can say with certainty that
the outlook depends on a number of specific issues. Among
them is the ability of the domestic economy to adapt to
changing conditions.
Industrial output grew considerably less in 2005 than in
the previous year. For the first nine months, the increase was
a mere 2 per cent, while GDP for the entire year will likely
not exceed 4 per cent. These unimpressive figures are partly
attributable to the heavy rainfalls and floods that affected
much of the country. At the same time, Romanian industry
and certain sectors in particular were hit by the severe
appreciation of the domestic currency, the rise in energy
tariffs, subsidy cuts and fiercer competition.
In general, the more domestic market conditions match
those across the EU, the harder it is for numerous local
companies to comply with the new terms of competition.
This is reflected in smaller growth of output and GDP. How
will domestic companies fare in the period to come? Or, to
put it differently, has industrial output reached a bottom, or
will downward adjustment, with its related painful costs,
continue for a while?
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If the bottom has not yet been reached, we may see

worsening numbers in the months to come. If the bottom has
been reached, the rate of growth in industrial output may rise
in 2006, although signs are not likely until the second
quarter. A speedier absorption of shocks would help GDP
growth to recover as well. A better harvest would assist such
a recovery considerably this years harvest fell an abysmal
12 per cent compared to 2004. However, too much optimism
is not warranted, considering that productivity gains were
relatively unimpressive in 2005.
The trade deficit has continued to grow rapidly, and the
current account deficit may have exceeded 9 per cent of GDP
in 2005. Given that GDP and industrial output growth have
slowed significantly, a question is calling out for an answer:
are such external deficits sustainable? In fact, there are
several aspects related to the rise in external deficits which
require clarification. The unimpressive productivity gains of
the economy this year seem to confirm the qualms I
expressed, in an article a couple of years ago, regarding a
major competitiveness challenge. The economy must
somehow cope with a sharp exchange rate appreciation
resulting from heavy money inflows from Romanians who
work abroad and other capital inflows which are attracted by
Romanias prospects of joining the EU (the so-called "Dutch
disease").
Some would argue that the external deficits are not
worrisome, given the "normal" growth of bank credit and the
presence of foreign capital in the banking industry, which
presumably translates into reliable long-term credit lines. But
such arguments have limits. In the real economy there is no
one-way street; painful corrections are inevitable once
deficits exceed certain thresholds. Were such a correction to
happen, it would involve a severe depreciation of the
exchange rate that could rekindle inflation.
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As for the new monetary policy regime of the National

Bank (NBR), namely inflation targeting, the real test will
come this year. The final four months of 2005, during which
inflation targeting has been practiced, are not conclusive at
all and it would have probably been better to postpone its
introduction for a while. The test will be highly demanding
since conditions are peculiar: Almost half of the money
supply escapes the NBRs control (because transactions are
euro and dollar denominated); interest rate differentials are
still high; and the boom of bank credit and capital account
liberalisation has eroded the NBR's ability to control money
supply. The 5 per cent inflation target for 2006 is
overambitious; 6 per cent to 6.5 per cent would be more
reasonable, considering the rise in gas tariffs and the
underlying inflationary expectations. Last year's target was
missed by a large margin inflation would have likely been
8.7 per cent to 8.8 per cent in 2005 as against the 6 per cent
initial target, prior to the introduction of the flat tax.
Though the public budget envisages a deficit of 0.5 per
cent for 2006, some of its underlying premises are
questionable specifically, those relating to GDP growth
and inflation. A budget rectification would have to consider a
revision of these premises. Budget execution must be tight
next year. At the same time, the financing of infrastructure
projects has to be increased. And special attention has to be
given to raising the capacity to absorb EU funds. An
adequate management of the key issues has the potential to
enhance Romania's investment grade.
The international environment, meanwhile, is under the
spell of major uncertainties, which are rooted in global
imbalances and the economic impact of various geopolitical
conflicts. Economic stagnation in Europe and elsewhere, as
well as the rise of China and other Asian economies, prompts
countries to resort to protectionism as a means of defending
domestic markets (the gridlocked Doha trade round speaks
130

for itself). The price of basic commodities and oil will

continue to be impacted by the rise of Asian economies.
These circumstances will have an influence on the Romanian
economy, though it depends greatly on EU markets.
Last, but not least, Romania has to make good on its
commitments to the EU; the better we do, the better our
chances of getting into the Union. Romania's political and
business leaders have the responsibility of better defining
national interests better, and in concrete terms. The EU has
its specific supranational interests; but it is also a
constellation of national interests which often conflict. This
reality poses numerous challenges to national decisionmaking processes. Failure to meet those challenges,
however, could carry the price of a delayed membership in
the EU, thanks to the safeguard clause. The stakes in 2006
are high.
Setimes 23.01.2006

NEWS MOSTLY GOOD FOR THE

ROMANIAN ECONOMY
Romania and neighbouring Bulgaria are less than three
months away from becoming the EU's newest member states.
Much recent discussion has focused on Brussels' insistence
on further monitoring and the reluctance of some existing
EU members to admit Bulgarian and Romanian workers. But
what about the economic situation in the two countries
themselves? Ultimately, the ability of both countries to
adjust to a new, competitive environment may have more of
an impact on labour flow than the policies decided on in
Dublin or London.
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As it happens, the economic prospects in Romania

have brightened just in time for membership. In many
respects, the country is booming. The GDP's growth rate was
6.9% in the first quarter of this year, and it sped up to 7.8%
in the second quarter. Disinflation has continued. December
to December inflation will likely be close to this years target,
5%, down from 8.6% in 2005.
Industrial production has made a remarkable recovery
after a series of heavy shocks. A severe appreciation of the
domestic currency (due to massive capital inflows) and a
sharp rise in energy prices (as a prerequisite of adjusting
domestic relative prices to EU levels) have strained not a few
industries in the last couple of years.
Indeed, the growth rate of industrial output slowed
down in 2005, and a bad harvest diminished the rise in GDP
to 4.5% in 2005 a sharp fall from the peak of 8.3% in 2004.
The speed with which industry has recovered suggests that
efficiency reserves are still quite high in the Romanian
economy and that shocks can be dealt with adequately,
provided management is good and the transfer of new
technologies is satisfactory.
Budget revenues have been bulging and may jump
above 32% of GDP this year (from around 30% last year).
This trend seems to vindicate those who supported the
introduction of the 16% flat tax in 2005. It should be noted,
though, that additional revenues have been pumped into the
budget because of a very high economic growth rate, and
also because the flat tax has been implemented in areas
where no, or lower, taxes were levied earlier.
Higher budget revenues help finance badly needed
investment in education and infrastructure at a time when EU
accession is putting pressure on the government to boost the
production of public goods. Unemployment is slightly above
5%, though this is due greatly to massive migration. Not
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least, rapidly growing exports are to be mentioned; their rise

has been over 18% in the first semester of this year.
Overall, the Romanian economy is cruising at a fast
pace, defying less optimistic forecasts. However, some
things need to be qualified.
To begin with, it is legitimate to ask whether the pace
of economic growth is sustainable. There are data that
compel a more nuanced view of the inner dynamics of the
Romanian economy. For instance, exports have been
increasingly outpaced by imports in recent years and the
current account deficit has surged to a probable 10% of GDP
in 2006. The financing of large current account deficits has
not been a problem in recent years, owing to large inward
foreign direct investment. But the situation may change in
the years to come, following the end of big privatisation
deals. Even if greenfield investment grows after EU
accession one should not bet on a complete offset effect.
Some analysts have warned of the threats that large
current account deficits pose to several emerging economies,
including Romania. These dangers must be assessed within
the context of free capital account rules (a must for a EU
accession country), the tightening of monetary policies in
both the EU and the United States, and, not least, the heavy
borrowing in foreign currency done by individuals and
resident companies.
However, budget policy cannot do much in order to
correct rising current account deficits when domestic credit
to and external borrowing by the private sector are surging.
At the end of July credit to the non-governmental sector
grew by over 100% in Romania, as compared to July 2005.
The share of internal credit to GDP in Romania is at the low
end of the spectrum in Europe, and commercial banks would
like to capitalise on the assumed bright prospects for an
economy that will become part of the EU in 2007, and that
has been growing very rapidly in recent years.
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Along with rising deficits, a number of other factors

inflationary pressures due to a rise in aggregate demand after
accession, a monetary policy regime (inflation targeting) that
implies exchange rate flexibility, and likely increases in the
burden on the public budget (due to EU accession
commitments and the need to develop domestic infrastructure)
point to a more sober view for the longer term.
A recent World Bank report hails Romanias reforms
and fuels high expectations for post-accession years.
Arguably, however, a growth rate that ranges between
5.5-6% annually is more in tune with the actual
underpinnings of the Romanian economy. Were these
underpinnings to move in the right direction, a higher durable
economic growth rate would be feasible.
The Romanian economy needs more fixed investment,
a better infrastructure and for sustaining growth rates of
above 6% yearly, on average, over the longer term. More
significantly, it needs faster absorption of new information
and communication technologies. R&D is expected to rise to
0.7% of GDP in 2007, but this is still far from the Lisbon
Agenda requirement of 3%. Even if the figure came close to
2% by the end of the decade, intensity of economic
innovation and the pace of new technology transfers will be
essential for Romania. For this to occur widely, good
management practices have to be undergirded by better
training. High technology absorption would raise overall
productivity and allow Romania to catch up economically
inside the EU as well as compete better in the global
economy.
If the growth differential stays around 4% in Romania's
favor, in conjunction with a possible 2% average annual
exchange rate appreciation of the domestic currency (until
adoption of the single currency), income per head in
Romania could reach around 60% of the EU average in a
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decade. Meanwhile, a high ratio of EU funds absorption

would help modernise the rural economy and reduce
migration. This would not be an unsatisfactory performance.
Public policy, though, will have to play a major role in
bringing it about.
Setimes 30.10.2006

EURO ADOPTION IS TO BE APPROACHED

CAREFULLY
Slovenia has adopted the euro recently while Lithuania
has been asked by the Commission in Brussels to wait
longer. At the same time, Poland, the Czech Republic and
Hungary have decided to prolong the timeframe for euro
adoption. As a matter of fact several new EU member
countries are coming to grips with the reality that the
adoption of the common currency is a more complicated
endeavour than initially thought.
Romania, too, is supposed to adopt the common
currency by the Accession Treaty. Its convergence
programme has set as a strategic target the adoption of the
Euro and the accession to the Monetary Union by 20122014. Arguably, stating this aim unambiguously can help
economic policy in Romania be more consistent. However,
one should not underestimate the difficulty of making an
objective, which is wrapped up in many technicalities, the
support for an inherently comprehensive policy platform.
Moreover, this platform needs to be easily digestible for the
public at large.
But clarity is not enough. There is the experience of the
actual functioning of the Monetary Union (MU) that should
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ring some bells. Firstly, there are premises that, supposedly,

enhance an optimal entry into the Euroland. By this I have in
mind not so much nominal convergence criteria (inflation,
interest rate differentials, public debt, exchange rate
volatility), but rather those that would make a good
performance inside the MU achievable: due flexibility on
product/service markets and of markets for production
factors (including labour), an adequate prior reform of the
welfare and pensions system which should take off some of
the expected additional burden on the public budget in the
future, a tax policy focused on the mobility of production
factors under single market conditions (labour migration
included). Such prerequisites are not at all easy to meet; they
imply a certain development level of the economy that must
in no way be accidental if the euro adoption is to be
successful. After MU accession the only macroeconomic
instrument left to national policymakers, for adjustment
purposes, is the public budget. Unless domestic markets
function properly to put a too heavy burden on the public
budget would have a boomerang effect; the economy could
stall in recession if the intention were to reduce excessive
external deficits as shown, inter alia, by the Portuguese
experience. Italy, too, indicates how tricky operating inside
the MU can be unless markets adjust smoothly, rapidly.
Economic policy after accession has to deal with
unavoidable and complicated trade offs, for which theory
does not always have clear solutions. For example, major
trade offs are entailed by the complete liberalization of the
capital account when domestic interest rates are still high
(and attract hot money inflows). Let me give another
example that regards catching up economies. Emerging
economies need massive investment in infrastructure, for
overall modernisation. Such investment stands for an
important growth of public and private expenditures which,
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unless accompanied by corresponding productivity gains,

would create inflationary fits while enlarging foreign
deficits. I share the view of those who argue that the
Maastricht criteria seem to be less applicable to emerging
economies, that are growing quite rapidly. And I say it not
only because of the Balassa-Samuelson effect (that posts a
pretty fast rise in the prices of non-tradeables). I refer in
particular to a possible conflict between a considerably
larger public budget (with public expenditures that may rise
by 4-5% of GDP due to the use of EU funds and required
rises in public expenditure following EU accession) ) and the
sustained disinflation that is required by accession into the
MU. The more complex and bigger an economy, the more
difficult to tackle macroeconomic trade-offs. As I mention
above the Czech Republic, Hungary (apart from obvious
errors made in the last ten years), Poland are among the new
EU member countries that have extended their MU accession
time-line because of the inherent difficulties of dealing with
major policy trade-offs. For Bulgaria, Romania and other
countries another factor worth mentioning here is the upward
pressure on wages caused by steady migration, that may
make it rather difficult to reach an inflation rate of around 2
per cent on a durable basis.
There is another aspect related to the functioning of the
MU that should provide food for thought. There are countries
which behave like free riders, counting on an easy financing
of their deficits (see bonds issued by government bodies or
companies at low spreads) without being able, seemingly, to
put their public budgets in good order. A taboo in Brussels
and Frankfurt is the viability of the Monetary Union, which
is understandable; for the euro is as much a political
construct as an economic one. Nonetheless, too many freeriders could bring the Monetary Union into a situation where
137

the benefits from being a member of the euro zone could be

outrun by costs. A one size fits all monetary policy would be
increasingly unwelcome under such conditions.
Therefore, the debate on MU accession must address a
wide range of issues and circumstances while it has to
acknowledge that this target is set forth by the Accession
Treaty of the new EU member countries. This debate needs
to be accompanied by an analytical understanding of
unavoidable trade offs among key policy targets within the
framework of longer term economic policy planning and
making. The public policy will have to find the way in order
not to sacrifice real convergence for the sake of expediting
nominal convergence that, later on, would turn out to be
ephemeral.
The adoption of the euro should not be seen as an
ultimate target on its own, but rather as a means to diminish
the economic divides that separate new member states from
the rich member states of the Union. Consequently, euro
adoption has to be formulated and made operational in
realistic terms Countries from Southeast Europe should
consider carefully the pros and cons of rushing into euro
adoption. The functioning of a currency board regime may
speak in favour of a quicker euro adoption as would a heavy
euroization of the economy (as is the case in Croatia). The
size of the economy is also in important element to consider
(and most Balkan economies are quite small). But, as I have
tried to highlight in this article, this decision hinges on much
more. Not least on clear prospects of joining the EU.

PART IV
THE BALKANS AND THE EU

Setimes 12.03.2007

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139

ECONOMIC RECONSTRUCTION:
THE ROLE OF EUROPEAN AID

The terrorist attacks on 11 September re-ignited the

debate on the links between poverty, social destitution and
what breeds deep resentments, inter-ethnic conflicts and
terrorism. Europe, too, is not devoid of dismaying events,
with the Balkans' last decade epitomizing much of what is
evil in the contemporary world. It is no secret that the Balkan
countries need substantial aid "to come out of the woods".
How can one judge aid in the Balkans, which should help
achieve peace and enhance economic development?
Some pundits make an analogy with the end of World
War II in evaluating the Balkans even proposing the idea
of a new Marshall Plan for the region. But, arguably, one
should rather be cautious in making such a comparison, in
over-stretching the relevance of history.
There are several motives in adopting a cautious
approach. First, at that time there was no process of stateformation and dissolution and, therefore, no ensuing
conflicts. This sparked, down the line, the start of the process
of economic integration by the formation of the Coal and
Steel European Community. Second, the war did not involve
revision of borders. This is not the case in the Balkans
nowadays, where borders have been and, still are questioned.
Third, the Marshall Plan meant, primarily, an infusion
of funds for energizing economic reconstruction in an area
which possessed the institutional ingredients of a market
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economy. This is clearly not the case with large portions of

the Balkans, in spite of the decades of market experience of
many of the inhabitants of the states, which previously made
up Yugoslavia.
Fourth, there was, at that time, a big common enemy:
communism, external and internal. Who is the big common
enemy of the peoples in the Balkans, at the start of the new
century? The prime candidates would be poverty,
underdevelopment and crime in an area, which, yet, belongs
to a prosperous continent. But this is an imprecise enemy and
not easy to deal with by looking at worldwide experience.
These observations are not meant to downsize the
importance of aid for the Balkans. On the contrary,
assistance is badly needed, it should be considerable, but it
should also be wisely calibrated and provided. Aid needs to
take into account the complexity of intra-regional relations,
the still murky political geography in parts of the region, the
existence of latent conflicts, the prevalence of weak
sometimes failed states, etc. This extremely complex
situation links national economic objectives with other goals,
such as peace and security. At the same time, the stability of
the region as a whole can be viewed as a collective good, a
public good for Europe.
Whereas goals can be easy to define in abstract terms
peace and security, social cohesion, economic growth they
are much harder to formulate and pursue practically. This is
particularly hard when the goals imply irreconcilable
objectives of governments that do not show a high
propensity to co-operate, or when these goals have to be
pursued under very adverse circumstances.
In the Balkans, this situation is quite ubiquitous and
explains the heavy presence of outsiders, the existence of
protectorates both "hard" and "soft". But foreign presence
does not simplify the solution to problems automatically, as
the experience of Bosnia and Herzegovina indicates.
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Tackling the problems of Southeast Europe demands a

vision, which should frame the policies of both domestic and
external actors. This vision, and ensued policy, needs to
consider the consequences of the years of immense
destruction brought about by military conflicts; failures of
reform efforts; and the still very complicated nature of
relations inside the region. All of these factors should be
viewed in conjunction with a developmental challenge.
These lessons are most relevant when one considers the
distress state of several economies in the region, where
unemployment rates hover between 20 per centand 30 per
cent, poverty is widespread and on the rise, current account
deficits approach 10 per cent of the GDP, and infrastructure
is very precarious.
A development policy needs to take into account what
is realistic to achieve without shunning bold action; it also
needs to put the whole endeavor into a realistic timeframe,
keeping in mind the intricacies of the situation on the
ground.
Policymakers should cast their endeavors under three
major headings: crisis management; economic reconstruction;
and institutional change. Dealing with the Balkans needs to
be judged from two inter-related perspectives. One is the
exercise in dual (short- and long-term) crisis management,
which aims at arresting, and reversing where possible, bad
dynamics and path-dependencies.
The second perspective concerns reconstruction, which
would have to be a two-pronged strategic endeavor: physical
reconstruction and development (including institutional
change and the political process).
The Balkan countries need to do the most they can; and
their governments bear first accountability for economic
performance. But Europeans, in general, have a big stake in
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helping the people in the Balkans rid themselves of the

demons of the past and the present.
Setimes 14.04.2002

UNEMPLOYMENT IN THE BALKANS:

HOW MUCH OF A CONCERN?
Unemployment rates have been persistently hovering
around 40 per cent in Bosnia and Herzegovina (BiH),
between 30 per cent and 32 per cent in Serbia and
Macedonia, between 16 per cent and 18 per cent and even
higher in Albania, Bulgaria and Croatia, in recent years. In
Kosovo, the rate is very likely to have gone substantially
beyond the level encountered in BiH, which is quite
ominous.
There is, clearly, significant diversity of conditions in
the labor markets of the countries, shown by the range of
unemployment rates. But one fact is indisputable: the
intensity of the phenomenon is quite unusual by European
standards.
Extremely high unemployment rates can mould social
and economic dynamics in perverse ways, which may hinder
the Balkan countries' quest to embark on sustained economic
development.
Overly high unemployment depreciate the high literacy
rates and good educational levels of these countries. If
unemployment is reduced, these factors will entitle the
countries to aspire to rapid economic growth, due to the
emergence of knowledge-based ecomony. In addition,
unemployment rates breeds social strife, raise some
144

individuals and groups' propensity to engage in illegal and

criminal activities, and favour the proliferation of nonconventional threats.
Years of devastating wars and interethnic conflicts
have taken their toll and explain much of the state of
economies in the region, including high unemployment rates.
At the same time, the inability of local economies to undergo
sufficient restructuring and create new jobs for the labour
shed by idle industrial plants adds to the situation. The
expanding service sector as is the case in all transition
economies cannot compensate for the destruction of old
jobs, unless new enterprises emerge at a rapid pace.
Many have turned to underground economy [those
enterprises that avoid paying taxes], which is not necessarily
engaged in socially pernicious activities; the underground
economy, at the end of the day, helps people make a living.
Nonetheless, low tax revenues undermine state capacity to
provide public goods, which further damages social cohesion
and overall stability.
This is a catch-22 syndrome, which leads to caution
when treating the underground economy as benign. Spain's
experience with very high unemployment rates more than
20 per cent in the late 1980s and the early 1990s at a time
when the country was evincing impressive economic
performance, proves this.
Dealing with high unemployment rates is not easy. The
Balkan economies need to be able to grow on a sustained
basis, and the recipe for rapid growth is not readily available.
There is need for much more: clear rules of the game,
enforcement of laws and regulations, enforcement of
property rights and less bureaucracy simultaneously with
state capacity to protect citizens' rights. Local economies
also will need substantial infusions of capital from abroad
foreign direct investment, in particular, which should create
new jobs.
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The Stabilisation and Association Agreements, which

are in place by most Balkan countries with the EU, as well as
the Stability Pact, have a major role to play in shaping public
policies. The World Bank, which is more attentive to
fostering "good growth", has an essential role to play as well.
Unemployment rates in the Balkans reflect much malaise and
social chagrin, and they should become of paramount
concern to those who formulate public and economic policies
in the region.
Setimes 24.05.2002

WILL ECONOMIC RECOVERY LAST

IN THE BALKANS?
The recent annual meeting of the EBRD in Bucharest,
brought a big piece of positive news for Southeast Europe:
economic recovery seems to be well under way in the region,
and the region's overall economic dynamic overcame the
pace of growth in Central Europe for the first time.
The numbers, provided by Willem Buiter, chief
economist of the EBRD, speak for themselves: last year, the
rise in the GDP was 7.3 per cent in Albania, 5.6 per cent in
Bosnia and Herzegovina, 5.5 per cent in Yugoslavia, 5.3 per
cent in Romania and 4.5 per cent in Bulgaria. Only
Macedonia recorded a fall of 4.5 per cent due to the
interethnic and military conflicts which ravaged the country
last year.
Can this recovery last? Without economic growth, a
country can hardly achieve the increase of income per capita,
which is a must in order to deal with the frustrations and
pains of the population, after so many years of destruction
146

brought about by interethnic strife and wars. Growth is also

badly needed for job creation, in countries where
unemployment has climbed to amazingly high rates.
Countries in the region need growth in their quest to
join the EU, which has become a paramount foreign policy
objective. Only Bulgaria and Romania were invited to start
accession negotiations in December 1999, but they will not
be included in the first wave of EU eastward enlargement.
The rest of the countries have signed Association and
Stabilisation Agreements with the EU.
For EU accession to happen, these countries need to
embark on growth paths. Against the background of an
increasingly complicated internal metabolism of the EU
with many EU citizens voicing their fears about including
relatively poor European countries and thus, the subsequent
redistribution policies political realities are forcing Balkan
countries to try to "pull themselves by their bootstraps"
economically, and show some signs of local economic
strength.
There are positive signs in the region, which provide
ground for optimism. Price stability is almost general, with
inflation rates well under control. Bulgaria and Albania
achieved remarkable turnarounds after the financial debacles
of 1997. And in Romania and Yugoslavia, disinflation is
advancing. The financial and banking systems have made
some headway in all the countries. Investment inflows seem
to be on the rise in Romania and Croatia direct investment
exceeded $1 billion last year, and hundreds of millions of
dollars were invested in Yugoslavia.
There seems to be a restoration of trade links among
neighbors as well. The governments in Zagreb and Belgrade
entertain thoughts of jumping on a faster track regarding
their goal of joining the Union. Some see this desire as
realistic, in view of the resources both these countries benefit
from, even after the dire past decade.
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Policymakers have to be aware of the fallacy of taking

the current recovery for what it is, which is not yet steady
growth. Several factors impede growth in the region. The
very logic of recovery itself recovery is not growth. The
latter involves substantially higher rates of investment and
productivity gains. On both accounts the regions has a long
way to go. Another obstacle is the fragility of institutions,
which would likely cripple economic policy over the longer
run unless this issue is addressed adequately. Weak states do
not have a good record of economic development. It is not
clear whether the proliferation of protectorates, whether hard
or soft, could provide the magical solution in this respect.
Another factor to consider is the heavy dependency on
external assistance, as in the case of Bosnia and
Herzegovina, Macedonia and Kosovo. Should foreign
assistance decline, severe crises would erupt.
There is positive economic news coming out of
Southeast Europe that needs to be built upon to face the big
challenges ahead. Dealing with these challenges effectively
will make the difference between embarking on growth
trajectories or being mired into stagnation.
Setimes 15.07.2002

INFRASTRUCTURE IS KEY TO ECONOMIC

DEVELOPMENT AND COOPERATION
It is no secret that roads, bridges, and ports in the
Balkans were severely battered during the past decade of
military conflict. In addition, the infrastructure was already
quite underdeveloped in some regions of Southeast Europe.
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This combination of circumstances has further distanced the

Balkans from the economically advanced parts of Europe.
Infrastructure has played an increasingly significant
role in fostering economic development; it has also led to
discrepancies between various areas of the region. While
telecommunications can override the importance of
geographical proximity in today's world economy, a broad
range of activities still demands quick and flexible
movement of people and goods across frontiers. In this
respect, Southeast Europe has a long way to go in order to
connect with the West and bolster the region's credentials.
The role of infrastructure can be judged from several
perspectives. It is hard to sustain economic growth in the
absence of adequate infrastructure; bottlenecks easily appear,
stifling growth. The region as a whole lacks good road
networks (highways, in particular), which would facilitate
links with the main western markets.
Bridges, too, are insufficient not only in areas
affected by war, but also in the stretch of the Danube
between Bulgaria and Romania. Only lately, as a result of the
Stability Pact, a second bridge is to be built between the two
countries. Railways need to be modernised all over the
region.
One reason for local governments and donor agencies
to focus on infrastructure is that most Balkan countries have
high levels of unemployment and poverty, and these are the
biggest worries of people living in the region.
Unemployment rates are in the range of 30 per cent to 35 per
cent high compared to conventional European benchmarks.
Such unemployment rates cause hardship and poverty, breed
resentment and encourage brain drain and migration. They
also steer people towards the underground economy and
criminal activities.
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Infrastructure development would help deal with

massive unemployment. Public works are labor intensive and
have spillover effects on other industries. Development
would also help restore economic ties among the new states
in the Balkans.
Politicians and policymakers frequently invoke
regional co-operation and trade as desirable goals. But it is
hard to imagine intense co-operation and development taking
place unless major infrastructure projects are worked out and
developed throughout the region. At the same time,
infrastructure development is not easy to undertake
tensions linger and some borders are still contested. Yet there
is obvious room for progress, and the EU can play a major
role in helping advance co-operation.
Brussels should be interested in fostering the
development of adequate infrastructure in the Balkans, as it
would help the region join the EU. The prospect of Bulgaria
and Romania joining NATO would create a new framework
for co-operation in the Balkans; both the old and the likely
new members in the region would have strong incentives to
develop infrastructure projects for mutual benefit and,
consequently, for the benefit of Southeast Europe as a whole.
Aside from vision and good, practical ideas,
infrastructure development needs considerable financing.
The European Investment Bank, the structural and cohesion
funds of the EU, the World Bank and the EBRD can be of
much help in providing badly needed financial aid. Likewise,
national governments need to plan their budgets accordingly,
in the sense of considering the financial requirements of
projects which have a regional dimension. For this to
happen, there is a need for governments to co-operate more
closely and for finance ministries to work together and make
necessary provisions in national budgets.
Setimes 30.07.2002

150

THE LATIN AMERICAN CRISIS:

LESSONS FOR THE BALKANS
The IMF announced a rescue package, of $30 billion
for Brazil, following an assistance program for Uruguay.
Both of these countries have seen their financial markets and
banking systems severely and adversely affected by the
economic debacle in Argentina. The turmoil in the Southern
Cone of Latin America indicates that contagion crises are
still very much alive and that the functioning of world capital
markets is still fraught with threats. The crisis in this region
can serve as an education process for the Balkan countries.
It is clear that contagion containment is quite
unfeasible when interdependencies are powerful, as is the
case with the three countries mentioned. In this respect,
Balkan countries seem to fair well to the extent their capital
markets and trade are considerably less integrated. But one
should not be complacent about it to the extent, and by
assuming gradual peace reconstruction, trade and financial
links in the region will develop at a fast pace.
Similarly, low inflation and monetary stability can be
pretty deceptive when deep-seated imbalances are not dealt
well adequately and in a timely fashion. Sooner or later,
tensions surface and crises erupt, possibly violently. In the
Balkans, low inflation is ubiquitous. Nonetheless, there is
huge unemployment region-wide, which is likely to increase
governments' reluctance to undertake painful restructuring
programs unless job creation is intense.This is why the
current economic recovery in the region would be great to
continue, so that further reforms should be accompanied by
new job creation. A plus of this recovery would be the
development of small and medium sized enterprises.
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In several Balkan countries there is heavy dependence

on foreign assistance. There are two aspects which merit
attention in this respect. Some countries may develop
unsustainable patterns of consumption and trade imbalances
should aid be discontinued. Bosnia and Herzegovina (BiH),
Macedonia and Kosovo are prime candidates in this regard.
Another aspect is the capacity to shoulder external
indebtedness. Balkan countries are not, on average, as
heavily indebted as Argentina and Brazil, and they have been
capable of running relatively low fiscal deficits in recent
years. But the currency boards, which function in Bulgaria,
Montenegro and BiH, can become a liability unless domestic
productivity gains are steady and substantial. Trade
imbalances must be contained and foreign direct investment
(FDI) must hold the lion's share in total capital inflows to
keep the currency boards stable.
This is particularly important in view of the size of
unemployment and the need to preserve a modicum of social
cohesion. As data clearly indicate, productivity gains are
feeble and the rise in exports is insufficient and FDI is
below expectations. However, the current low level of FDI is
linked with poor economic conditions in Europe and the
United States and the fragility of local institutional set ups. A
possible combination of rising external indebtedness with
high unemployment, low growth and stagnant exports would
be quite explosive.
Balkan countries trade prevailingly with the EU and
their pegging where it is the case is with the Euro, which
makes a big difference as against Argentina's experience.
However, productivity gains are a must in order to avert
threatening external indebtedness and balance of payments
crises. The geographic proximity of the EU is not
insignificant, but it is far from providing the kind of shelter
these countries need.
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Similarly, thinking of early euroisation as a shortcut is

not devoid of major risks and may not be, technically
speaking, possible unless Brussels condones it, as the US did
in the case of Ecuador.
In Argentina and Brazil, provincial governments, by
running lax fiscal policies, have put tremendous strain on the
federal budgets, which contributed to over-indebtedness. In
Southeast Europe, governments are weak and where fiscal
deficits are low, they may not be sustainable over the longer
term. This reasoning would be reinforced should domestic
capital markets further develop and local municipalities start
to tap them by issuing bonds. Hard budget constraints have
to apply as a basic rule in the economy and that central
public authorities have to monitor finances at the local level
as well.
Poor public and private sector governance is also to be
highlighted, as well as the stemming influence of corruption.
Deeply entrenched corruption and the cynicism of politicians
can destroy any credibility of public institutions, which can
further harm democracy and produce chaos when economic
crisis spreads around. Argentina epitomizes such a tragic
situation.
In the Balkans, attracting more FDI is a major concern,
as it is sorely needed to build up infrastructure, restructure
and modernize the energy production and distribution sector.
But in order to achieve good economic performance,
privatization should be accompanied by good corporate
governance and an effectively implemented regulatory
framework that can deal with monopoly behavior, secure fair
prices for consumers and avoid external over-indebtedness.
Privatisation in the energy sector needs to be buttressed by
well-balanced contracts, which should reward investors as
well as protect the local economy. In Argentina, sweetheart
deals in questionable privatizations allowed the charging of
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extremely high rates. Arguably, the very high price of

services has contributed significantly to the growing loss of
competitiveness and the rise in external indebtedness.
At the same time, the flow of foreign capital should be
carefully monitored as Balkan economies continue to open to
the wider world and fully integrate with international
financial markets; much caution should be exercised in
opening the capital account.
A final lesson is that brilliant expertise, at the very top
level, may not be sufficient to stem the tide. Both Argentina
and Brazil benefited on highly trained public servants
ministers or governors of the central banks, some of them
with stints in the international financial institutions (IFI).
There is need for clever policies, which should be pragmatic
and shun intellectual fundamentalism and respond to local
circumstances in due time. At the same time, the debacle in
the Southern Cone is another lesson for the IFIs about what
is wrong with the current international financial system.
Setimes 23.09.2002

TAX POLICY IN SOUTHEAST EUROPE:

SOME ISSUES
There are major differences in the effectiveness and
efficiency of taxation among transition countries. On the
average, Central European governments have been more
effective at collecting taxes than the majority of their
counterparts in Southeast Europe. Quite likely, this
performance has been due to stronger public administration
and institutions. Some basic constraints affect taxation in
transition economies.
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The legacy of a sort of "welfare state" means that many

citizens are used to getting abundant public goods in a period
of deep retrenchment of public budgets. This legacy is
reinforced by a Catch-22 syndrome: the production of private
goods is crowded in by basic public goods, but the very
expenditure assigned to the supply of public goods may
overtax private firms. The fragility of institutions is reflected
in a poor capacity to collect taxes or enforce laws and
regulations. Substantial hidden, private taxation occurs in
transition economies bribes and protection taxes raise the
cost of business. Firms may be willing to pay taxes to a state
that can enforce laws or at least enforce them better. But how
can this transformation take place, and the deadlock be
unravelled? Hidden private taxes combine with the
temptation firms have to evade taxes and operate in the
underground economy. Last but not least, transition countries
differ widely in their ability to raise money on foreign capital
markets.
Which structure and level of tax revenues should a tax
policy target? OECD member countries generally show a
higher level of tax revenues than developing countries. But
the OECD area itself presents variety. Some Mediterranean
states Spain, Portugal, Greece collect less, while their
informal sectors are significantly larger. While signposts do
exist, one must be careful since there are striking differences
even among the countries that supposedly provide good
practices.
Wealthy countries used a different level and structure
of taxes when they were at an inferior level of economic
development. How does this fact bear on the suggestion,
which some have made, of using their current taxation
systems as signposts for tax reform in transition countries?
And which best practices does one have in mind? Can an
economy leapfrog development stages just by trying to
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imitate institutions? Do best practices mean uniform rates?

Does it make sense to look at the experience of the few
economies that achieved remarkable economic progress
during the last decades? And to what extent do globalisation
and the rules and regulations of the international economic
system allow an economy room for using fiscal devices with
the aim of fostering growth?
The developmental challenge may be less relevant for
the accession countries, although they too have to close
major gaps with the West. But it is certainly becoming of
paramount importance for Southeast Europe. The
conventional wisdom and the advice provided by
international financial institutions stresses the need for fiscal
neutrality. But how can the least distortionary effects of taxes
be judged in a world in which there are numerous
externalities, asymmetries, adverse external shocks and
multiple equilibriums?
The efficiency of national taxation systems should be
judged in relation to the international tax regime. One can
question the effectiveness of the fight against tax evasion and
avoidance when individuals and firms can use tax havens.
Likewise, the fight against tax evasion and avoidance should
be seen in the context of combating money laundering, as
well as against the backdrop of the struggle against international
terrorism.
Most Southeast European countries are adjusting their
legislation to EU norms in their quest to join the Union. The
EU's financial assistance also plays a role, for it can fill in
budget holes and mitigate tax reform pains. On the other
hand, the financial benefit of this assistance needs to be seen
in conjunction with the impact on budget revenues of
nominal convergence criteria, which are both quite
demanding and highly relevant for the accession countries.
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Southeast European countries need to improve taxation

efficiency in order to raise budget revenues. To this end, an
overhaul of tax administration and simplification of the tax
system are needed. But simplification need not turn into
policy fundamentalism. EU member countries use the logic
of non-distortionary taxation in a flexible way. There is a
need for tax regimes that are friendly to investment, from
wherever it comes. But this goal does not clash with
providing incentives to FDI when the latter engages in
greenfield operations, which create jobs, bring in new
technologies and have trickle-down effects that benefit the
entire economy. These incentives do not harm budget
revenues when they genuinely involve new investment. A
friendly business environment attracts FDI, but there is a
time constraint at work. A proper business environment
cannot be created instantaneously, whereas fiscal incentives
can sometimes provide a competitive edge to governments
that badly need investment from outside.
Low taxation and simplified regulations are essential
for the development of small- and medium sized enterprises
(SMEs). But good ideas and entrepreneurial spirit may not be
enough when there is a need for bank finance and banks
demand hard-to-obtain collateral. The Bank for International
Settlement's new regulations on banks' provisioning for loans
could hit small- and medium-sized firms severely, unless
banks find creative ways for financing. Capital markets
function poorly in Southeast Europe and self-financing is
often not an option. One way to mitigate the difficulties of
SMEs is to set up specialised financial institutions to cater to
their needs. It is a positive sign that the EBRD is among the
sponsors of SME-focused banks set up in the region.
Setimes 9.12.2002

157

ABSORPTION CAPACITY OF EU FUNDS

PLAYS CRITICAL ROLE FOR MEMBERSHIP
SEEKING COUNTRIES
The capacity to absorb EU funds will play a critical
role in Bulgaria and Romania's quest for accession over the
next few years. Other Balkan countries are also banking on
increased financial assistance from the EU for their
development efforts. It makes sense, then, to take a close
look at the issue of absorption capacity of external funds.
There are several important considerations. To begin
with, the issue is important to all the accession countries.
Countries that are more fragile institutionally and have a
more difficult time fighting vested interests and corruption
are less likely to use EU funds efficiently. Structural funds
are more important when the economy is weak, while the
marginal benefit of an efficient use of structural funds is
higher in less developed economies. Use of EU funds should
be seen in the wider context of a country's ability to use all
available resources, whether domestic or imported,
productively.
A distinction should be made between an acute
shortage of resources and the capacity to absorb them
efficiently. Poor countries, despite their hunger for resources,
generally have a limited capacity to absorb funds efficiently,
to a large extent because of their precarious institutions.
While absorption capacity can be seen in a static or dynamic
way in both cases this capacity is variable at any one point
in time, a country can use more or less resources less or more
efficiently. In both static and dynamic terms, absorption
capacity depends on parameters and variables. The
institutional setup is a parameter in the short run, but turns
into a variable over the longer term. Policy choices are a
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variable both in the short and the longer run. Defining

priorities (as a policy choice) is also a variable. The
formation of coalitions of interested parties in favor of reforms
is also a variable.
It is not sufficient to examine a country's absorption
capacity in a purely national context. Attention must also be
given to the international context and to EU policy dynamics.
At the last Copenhagen summit, for example, considerable
debate took place concerning the amount of financial
assistance to the accession countries. There are powerful
voices in the Union that argue that regional policy has not
been as successful over the years as some might claim. In
addition, mounting economic difficulties in the EU reduce
the appetite of the richer countries to assist the poorer ones
financially, and this syndrome is likely to shape future
choices in the field of regional policy. Some argue that the
EU should provide more assistance to the Western Balkans
in the years to come, while powerful tensions persist in that
region. More resources granted to the Western Balkans
would compete with other uses; the outcome would hinge on
the way Brussels judges future costs and benefits of its
assistance. If Croatia, for instance, achieves better economic
performance, its hopes of being put on a faster accession
track on par with Bulgaria and Romania could turn into
reality and the country would be entitled to more assistance.
For reasons such as those highlighted above,
policymakers in each country need to better define the
challenge of absorption capacity, analytically and
operationally. EU funds should be included in the
multiannual budgeting of finance ministries. Their use
should be considered in an overall framework, accounting
for all resources utilised by the public budget. It is important
to learn from other countries' track records in using such
funds in order to avert avoidable errors.
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Absorption capacity should be related to budget policy

and its capacity to provide public goods. Tax collection can
be much improved, and reforms of the fiscal administration
are more than welcome. The tax system needs to be
simplified, in order to ease its administration and reduce
compliance costs. But the simplification of the tax system
should not turn into policy fundamentalism; EU member
countries themselves use the logic of non-distortionary
taxation in a flexible way. Unless corrected, the significant
difference in mobilisable public resources compared to
Central European countries favors a rise, to Southeast
Europe's disadvantage, in income per capita differentials in the
years to come. The paucity of public resources is an additional
argument for raising awareness about the importance of
using EU grants wisely, and for a skillful budget policy
which aims at providing badly-needed public goods.
Accessing EU grants productively requires a
systematic concern for raising local absorptive capacity; this,
in turn, depends on a major overhaul and reform of public
administration. Beneficial projects should be embedded into
multiannual budgeting programmes of ministries, with
careful monitoring of their implementation so that waste and
fraudulent diversion of resources can be avoided. Budget
policy should focus more on defining priorities, reducing
waste and combating corruption.
Setimes -26.05.2003

CONFLICTING PERCEPTIONS
AND ECONOMIC CHALLENGES
An apparent clash of social, political and economic
dynamics can puzzle attentive observers of the Western
160

Balkans. There have been a series of positive developments:

wars and violent interethnic clashes have been stopped,
democratically organised elections have taken place and
political legitimacy has been established throughout the
region. Inflation has been brought under control, with rates that
are amazingly low and some economic recovery has occurred.
In fact, Southeast Europe including the Western Balkans
overtook Central Europe in terms of GDP growth in 2001,
and will possibly do the same in 2002.
Such tendencies are frequently highlighted by
international officials such as High Representative in Bosnia
and Herzegovina (BiH) Paddy Ashdown and UNMIK chief
Michael Steiner; by reports of IFIs (the EBRD's latest annual
report, for instance) and by the head of the Stability Pact, Dr
Erhard Busek, among others. It would be foolish to
underestimate these positive tendencies and not try to
capitalise on them. On the other hand, it would be equally
foolish to ignore the dark side of the story and the tensions
which continue to strain the region.
As a whole, the region is plagued by massive
unemployment, totaling about 30 per cent of the entire active
population in Serbia and Macedonia, 40 per cent in BiH and
more than 60 per cent in Kosovo. Such unemployment helps
breed criminality and the underground economy. The
staggeringly high rates, together with the decay of industry,
recalls the earlier decades of the last century, when the
region's economic backwardness prodded the well-known
economist Paul Rosenstein-Rodan to speak of the need for a
"Big Push" to foster development.
There is an increasing addiction to foreign aid, which is
debilitating to the extent that it does not foster viable
economies and mainly finances consumption. It is true that
this assistance has helped rebuild infrastructure, but
consumption-related aid is conspicuous. The migration of
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young and skilled labor is gathering pace, depleting the most

valuable asset of the region. Low saving and investment
ratios throughout the area indicate that current economic
recovery has a low chance of turning into sustainable
economic growth, unless major technology transfers, which
induce substantial productivity gains, occur. But is the latter
probable in the short run? Inter-regional trade is still much
reduced, undermining production and efficiency of firms
which could supply their products and services regionwide.
In addition, the region is rife with organised crime which
often reaches the upper layers of government.
Many citizens are disappointed with the results of
unavoidably slow and vacillating reforms, and this shows up
in the polls; there is growing apathy among the electorate
(see the latest rounds of presidential elections in Serbia) and
nationalistic parties are staging a comeback. Constitutional
and status-related issues, as well as continuing interethnic
strife, could easily unleash new crises. Against this still very
complicated background it makes sense to keep
policymakers in the region and abroad alert to the danger of
complacency. The region remains Europe's hotbed.
The inherent difficulties of dealing with the unsolved
and often seemingly intractable challenges posed by the
Western Balkans could be compounded by events taking
place outside the region. One such event is the war against
terrorism, which sets new priorities and redirects resources
among the major outside players. The United States, for
obvious reasons, is likely to reduce its military and material
presence in the region, which would ask for an offsetting act
on the part of the EU; the latter would have to increase its
multipronged involvement accordingly. But this is not a clear
option or solution at a time of major economic strain in
Western Europe as well, and when "the big game in town"
162

seems to be EU enlargement. Economic pain in the West,

combined with a less than smooth unfolding of enlargement,
could reduce the amount of concrete attention paid to the
Western Balkans. This could happen at a time when there is
an acute need to support the still very fragile local
democracies and help move forward with economic
reconstruction and reforms.
Should the region disappear from the radar screen of
the West, it would be a very unfortunate, unintended
consequence for the local populations and for Europe as a
whole. This is why the EU, in particular, should not let this
happen. The summit in Copenhagen seems to have made
enlargement in 2004 irreversible. Bulgaria and Romania,
meanwhile, were given a time target for accession in 2007.
The summit was an excellent occasion to show that
European statesmen in spite of the pressures of such
turbulent times have not lost sight of an unfinished job.
And it was wise for the EU's leading politicians to send a
message that eventually the countries of the Western Balkans
will be invited to start accession negotiations, and that badlyneeded assistance will be available, over the long haul,
within the framework of a well-defined program. This
assistance will hopefully be increased for the region needs
more support and should be focused on turning economies
into viable ones. Rosenstein-Rodan's famous injunction, that
Southeast Europe needs a Big Push, has not lost its
meaningfulness. Can the EU rise to this historic challenge?
Likewise, responsible local politicians in the Western Balkans
have to continue the uphill battle of trying to deepen
democratic processes, mitigate interethnic animosities and
simultaneously improve their economies.
Setimes 3.02.2003

163

POSITIVE SIGNS OF COOPERATION

A leading international daily, the International Herald
Tribune, recently published a letter signed by four top
politicians from the Western Balkans. The event was highly
relevant for several reasons. To begin with, the letter was
published after Serbian Prime Minister Zoran Djindjic's
assassination, and was meant to show a strong common
determination in the struggle against criminal forces. The
fact that key decision makers in the region joined together to
assert publicly that their countries are ready to co-operate
and work hard in order to join the EU is significant. It
provided a clear signal that politicians realise their countries'
common destiny and the need to mend fences for the sake of
a better future, which is inextricably linked with a place in
the Union.
Such a letter, signed collectively, in a leading European
publication has not been seen in a long time. This fact in
itself epitomises an awakening of political elites in the
region, which understand that they have to speak up in a
forceful and convincing way in order to be heard by their
counterparts in the west. The letter indicated a common
awareness of the region's essential political and economic
needs. These include proceeding resolutely with economic
reforms and reconstruction; fighting crime and corruption;
dealing with massive unemployment, poverty and social
exclusion; promoting regional trade and co-operation; and
protecting human rights.
Although it was published at a time when international
attention is focused on the aftermath of the war in Iraq and
the ongoing fight against terrorism, the letter did not go
unnoticed. Renowned financier and philanthropist George
Soros subsequently signed a letter to the Financial Times,
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calling for the EU and International Financial Institutions to

grant soft credits to the countries of the Western Balkans in
order to aid their quest for economic reconstruction and
security building. He also asked for a firmer commitment to
the region by the EU. There are signs that the 21 June EU
summit in Thessaloniki will focus on the region, and that a
stronger commitment will be made with regard to its
eventual integration into the Union.
Signs, both inside and outside the Western Balkans, are
pointing in the right direction and providing hope. They
indicate processes of healing, of increasing co-operation, and
of economic reconstruction and assistance. It may be that a
sense of urgency has engulfed leading politicians in the
Western Balkans, which remains Europe's most volatile area,
but is no longer its most pressing problem in terms of
transatlantic dialogue.
A large part of the EU is mired in economic stagnation.
This has a serious impact on the candidate countries,
including those in the Western Balkans, which export
primarily to the Union. Economic stagnation in the EU fuels
protectionist tendencies, impeding a successful outcome to
the Doha trade round. This is an unwelcome development for
Western Balkan countries, whose exports are largely
agricultural products. Capital flows have been reversing their
tendency in recent years, following the bursting of the bubble
in the United States and financial scandals on both sides of
the Atlantic. As a result, the Western Balkans cannot expect
to benefit from private capital flows as needed. The low
savings and investment ratios in the region require
substantial amounts of capital inflows in order to enhance
sustainable growth.
These circumstances compound very difficult domestic
situations. Inflation is quite low in most of the countries, but
the foundations for steady growth are precarious, and there is
165

heavy reliance on foreign assistance. Huge unemployment

rates and large quasi-fiscal deficits, inadequate infrastructure
and fragile institutions complete the picture, which is one of
badly-needed reform and reconstruction. Since the
international environment is so complex, Western Balkan
countries should pull themselves together in order to offset
to the extent it is possible adverse shocks from outside.
As for the EU, the region provides a clear test for
judging the Union's skills in fostering peace, good
neighbourly relations and economic reconstruction in its
backyard. This is especially true now, since the EU has taken
over peacekeeping in Macedonia, and could eventually do so
in other parts of the region.
What happens in the region has implications for peace
and development in the world as a whole. Failed and rogue
states, economic and social decay, and military and
interethnic conflicts proliferate in many parts of the world,
and action is needed to address such phenomena. The way
Europeans, and specifically the EU, deal with the Western
Balkans can be seen as a test case. It indicates what lies
ahead for all of us.
Setimes 16.06.2003

EU CONSTITUTIONAL DISPUTES
AND SOUTHEAST EUROPE
Disappointment with December's failed EU summit in
Brussels convened in order to validate the first EU
constitution was apparent in many European circles.
Bitterness not only stemmed from the inability to solve the
166

voting rights issue, but also from the image that EU member
countries are seen as projecting to the world.
The key issue wasn't the dispute over the respective
provisions, which may have to change in view of evolving
circumstances. Rather, it concerned the lack of a rule for
changing rules, when the older mandates are no longer
appropriate. Crises have erupted before in the history of the
Union over the past decades, so it may be incorrect to
overestimate the significance of this one. Current conditions
may have made it unavoidable. The stakes which member
countries have in forging ahead with the Union are high
enough that compromises are likely to be found. The power
distribution issue does not pit heavyweights against other
heavyweights at least on the surface.
Much more complicated is the issue of which direction
the Union should take with regard to further political and
policy integration. And here the existence of dissimilar
visions is highly visible. This is why the talk about a variable
geometry in the making is quite meaningful. Variable
geometry is not something new and bits of it already exist in
the monetary domain, in the form of two groups of countries:
those which adopted the common currency and those which
didn't. What degree of variable geometry can the Union bear
without irreparable damage? That is a crucial question. How
the debate on the EU constitution evolves has significant
implications for Southeast Europe for Bulgaria and
Romania, which are slated to join the Union in 2007, and for
the Western Balkan countries, which hope to join eventually.
A scenario can be imagined in which compromises are
found in the not too distant future and the EU constitution
swings into operation under good auspices. This would take
place against the backdrop of a quickening economic
recovery all over the EU area while the first wave of
accession proceeds smoothly. As a result, prospects of
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accession for Bulgaria and Romania improve and this

process enhances the dialogue between the EU and other
aspirant countries. Such a scenario would require a strong
convergence of views among key players with regard to
foreign and security policy. Convergence of economic
conditions would also be a prerequisite. The low probability
of such circumstances suggests that variable geometry does
in fact operate within the EU. Nevertheless, accepting this
dynamic as a working assumption is not the end of the story.
Variable geometry, though it can develop into negative
forms, can also be of a benign nature.
A positive scenario would be one that combines no (or
few) major disputes among the main players in the Union
with economic recovery which would help reconcile
different views on economic policy; an improved dialogue
among donor and recipient countries; and a smooth
absorption of the first wave of eastern enlargement. Should
all these developments occur and Bulgaria and Romania
make significant economic progress, a second wave of
enlargement could take place in 2007. That in turn would
turn the focus directly onto the Western Balkan countries.
Should they embark on steady economic growth and
continue their institutional buildup, while also managing
border and political disputes, these countries would see their
accession prospects much more clearly. Meanwhile, the EU
would be more deeply involved in the region through various
forms of assistance. As an exercise in political forecasting,
we could say that the Western Balkans arguably have the
potential to become an inner periphery of the Union.
The debate on the chances for Turkey's accession
would also be facilitated. A less positive scenario would
have its roots in multiplying dissonances and frictions in the
Union, which would entail several power constellations and
induce counterproductive policy bickering. This would
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translate into the Union not achieving its established goals of

economic performance. A less smooth absorption of the ten
countries slated to join in 2004 would complicate matters
further. That would impact negatively on Bulgaria and
Romania's chances of joining in 2007, especially if the
electorates in the EU become highly resistant to further
waves of enlargement. Needless to say, it would also have a
negative impact on the EU hopes of countries in the Western
Balkans, in view of their economic woes and vivid political
history. Turkey's chances would be affected as well.
The bottom line is that the internal dynamics of the
Union matter extraordinarily for the member countries'
political and economic prospects; these dynamics matter
enormously, too, for the countries of Southeast Europe.
Nevertheless it remains clear that the countries of Southeast
Europe have to continue democratic reforms and strengthen
the institutional foundations of their economies, regardless of
the EU dynamics. The work has to go on.
Setimes 26.01.2004

EU ENLARGEMENT AND THE WESTERN

BALKANS
An important juncture in Europe's history occurred on
1 May. That day marked the first eastern enlargement of the
EU, which now includes eight former communist countries.
The significance of this event is enormous, both politically
and economically. The Czech Republic, Estonia, Hungary,
Latvia, Lithuania, Poland, Slovakia and Slovenia have now
completed their journey of transition and have rejoined
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mainstream Europe. For the EU, the enlargement amounts to

an institutional coupling of the Cold War-era West and East.
Hopefully, this wave of enlargement will proceed
smoothly and the new 25-member EU will be able to manage
its growing complexity in an effective way. Managing the
EU's increasing complexity is important per se, as a means
of making the EU more competitive, and also in terms of
bringing in other candidate countries. The second of these
issues relates to the functioning of mature democracy, which
entails accountability and the power of citizens.
The enlargement is significant geographically as well.
The whole of the central European region has entered the
EU. Moreover, the so-called Eastern Balkans Bulgaria and
Romania are slated to join the EU in 2007, provided
reforms continue at an adequate pace. At the same time,
Croatia seems to be moving on a fast track, following the
European Commission's (EC) declaration that the country is
fulfilling the political and economic conditions required to
start accession negotiations. That means Croatia can
entertain hopes of joining Bulgaria and Romania in the next
wave of enlargement.
However, there is bad news as well. Although a sort of
intra-regional stability has been achieved, as well as some
economic progress, the overall state of affairs in the Western
Balkans remains complicated. The political geography has
yet to be clarified; the final status of Kosovo is a highly
contentious issue. Bosnia and Herzegovina is still plagued by
uncertainties concerning its viability as a political entity, and
it is very fragile economically due to its extreme overdependency on aid from outside. Much of the region
continues to suffer from high unemployment and "brain
drain". Crime rates are high and corruption endemic. Savings
and investment rations are low, and the reconstruction of
infrastructure is proceeding slowly.
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The bottom line is that the EU has to get more involved

in "coaching" and assisting the countries of the Western
Balkans in their quest to achieve durable economic growth
and improve their institutions. To be fair, it must be said that
the EU already has a multi-pronged presence in the area,
including a peacekeeping role. Bosnia and Herzegovina is
providing a test ground for the EU's ability to act forcefully
and effectively in situations of need. However, there are
lessons which must be learned in order to achieve better
results.
One lesson is that a visible and strong EU anchor is
crucial for the stability of the region and its economic
development. Another is that the EU's approach to the
Western Balkans should not be based on the idea of an
economic level playing field. The oft-cited distinction
between "fair" and "free" trade is applicable here. The
countries of the Western Balkans need strong institutions that
will ensure effective private and public sector governance.
Domestic endeavours have an important role to play in this
regard. In practical terms, though, more is required.
The region needs assistance from the EU that will help
it defeat the traps of high unemployment, worsening social
cohesion and rising criminality. For development to take
root, well-conceived financial assistance should be
accompanied by adequate trade arrangements (preferential
agreements), regional infrastructure projects (roads, bridges,
power networks and airports), and measures to stimulate
inward foreign direct investment. Likewise, strong cooperation intra-regional and with the EU authorities is
needed to combat criminality. It goes without saying that the
economic development of the Western Balkans would also
bolster the fight against terrorism.
Europe's agenda is manifold, and increasingly includes
political and economic dynamics in the Western Balkans.
Therefore, the first wave of eastern enlargement is also a
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reminder of how much remains to be done on the European

continent.
Setimes 11.05.2004

WORLD BANK FORUM TARGETS GROWTH

IN SOUTHEAST EUROPE
The World Bank Forum convened in Munich,
Germany, at the beginning of May. The gathering brought
together top economic officials from Southeast Europe,
Germany and the World Bank. Ministers from Albania,
Bosnia and Herzegovina, Bulgaria, Croatia, Hungary,
Macedonia, Romania, Serbia-Montenegro and Slovenia took
part, and hundreds of German businesspeople were in
attendance. The forum's theme, Responsible Growth in
Southeast Europe, was quite telling.
During the last few years, economic growth has been a
general feature across the region. Economic reforms have
been advancing, to a greater or lesser extent, in all countries.
A perceptible change of climate has stimulated Foreign
Direct Investment. However, the Western Balkans still have
a long path ahead of them when it comes to institutional
build-up, premises for durable growth and social cohesion.
These issues made up the building blocks of the conference
in Munich, and were the focus of several panels: governance;
connectivity (infrastructure); human development and social
cohesion; and private sector development.
World Bank President Jim Wolfensohn has frequently
made the case that social and economic issues are
inextricably interwoven in development, that growth can
happen under various conditions and that its effects on
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people at large are not inconsequential. In the late 1990s, the

Comprehensive Development Framework was put forward as
a matrix for thinking about growth strategies. The framework
was resuscitated during the Munich conference, in terms of
the emphasis placed on social issues. Wolfensohn's keynote
speech at the Forum was an application of this vision to a
region where unemployment remains high by European
standards, where crime is widespread and where hopes have
yet to brighten for large segments of the population.
The Forum was quite indicative of the variety of
conditions in Southeast Europe. Slovenia and Hungary are
now EU member countries, and see themselves as a
"springboard" for investments in the region. Romania and
Bulgaria are focusing on closing the remaining negotiating
chapters of EU accession, and hope that 2007 will be the
year of their membership. For both countries the terms of
accession are of great importance, given the size of their
rural sectors, the need to modernise energy sectors and
infrastructure, and the very demanding EU competition
policy, which could bring many local companies to failure
unless competitiveness challenges are addressed in a timely
manner.
Croatia, which was recently put on a fast track to EU
membership, hopes to join along with Bulgaria and Romania.
Macedonia, too, has high hopes. In general, the countries of
the Western Balkans, in spite of political uncertainties and
status-related questions, are driven by the guiding belief that,
sooner or later, they will join the EU. They view membership
in the Union as the best anchor for stability and economic
development. The EU's engagement in the region is crucial,
and can be judged in terms of a strategic vision assistance,
economic and trade arrangements and labour flows.
At the Forum, Wolfensohn noted that there are 5
billion poor people around the world who badly need the
World Bank's attention. While this does not mean that the
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Bank is relinquishing its various assistance windows to the

region, his observation was a stark reminder that Europe
should not think about itself only, and that the EU has to
shoulder more responsibilities where it can and where its
strategic interests are unambiguous.
Debates were held on how to stimulate the
development of the private sector; on whether public-private
partnerships in the field of infrastructure development
can work in countries where income per capita is low; and on
ways to foster small- and medium-sized enterprises. The
discussion on improving public and private sector governance
showed that high-level policymakers and business people
know what the major challenges are; less known are the best
venues for overcoming obstacles.
In the end, tenacity, persistence, open-mindedness and
intelligence should carry the day. There is an enormous
amount of political, institutional and economic work to do in
Southeast Europe; miracles cannot be achieved overnight.
But the change is there and palpable, and joining the EU is a
beacon which stimulates further political and economic
transformation.
Setimes 21.06.2004

NATO MEMBERSHIP: WHAT IT MEANS

FOR ECONOMIC DEVELOPMENT
NATO and EU membership have been the twin
strategic goals of most European post-communist countries
since 1989. Entry into these two Western clubs signifies
belonging to an area of economic prosperity and political
174

freedom, secured by institutional and military links among

the member states.
It is easy to see why joining NATO is regarded as a
milestone in a country's economic and political development.
Membership requires meeting certain conditions that
demonstrate a country has reached a high level of economic
progress and political maturity. A well-functioning market
economy ensures a strong economic performance, which is
essential for supporting military infrastructure and
contributing to the Alliance's needs. Meanwhile, democratic
institutions secure individuals' fundamental rights and help
preclude domestic and regional conflicts.
However, questions can be raised concerning the
degree to which NATO membership impacts economics
development. The Alliance is no longer what it was during
the Cold War. The major ideological foe, Soviet
Communism, no longer exists. As a result, it has become
harder to articulate common interests in operational terms, or
to define concrete missions.
The impact of globalisation must also be considered.
With capital now flowing to all parts of the world, the most
dynamic economic area now appears to be the Pacific Rim.
The region is attracting enormous amounts of capital, with
China receiving the lion's share. Geopolitics cannot avoid the
need to assess the relative military, strategic and economic
weight of the main players; as these change, so does the
outlook for the Alliance.
In the evolving climate, NATO membership is only
one of the ingredients which can foster economic progress.
There are countries in the world which do not have the
benefit of being members of the Alliance, yet have made
great strides economically. Moreover, the key player in
NATO the United States must balance its huge
technological, military and economic resources against the
175

risk of overstretch. That impacts its ability to provide

material assistance to allies, as it did during the Cold War,
unless adequate quid pro quos can be established.
One avenue may lie in the "strategic partnerships"
which have proliferated in recent years and which
increasingly shape bilateral ties. But these partnerships are
insufficiently defined when it comes to concrete economic
co-operation and mutual gains. In some cases, they may
clash with the rules set by other organisations, particularly
the EU. A case in point is the Braov-Bor highway project,
which has become an object of scrutiny by the European
Commission after Romania gave the contract to Bechtel
without a proper tender.
For Bulgaria, Croatia and Romania, NATO
membership needs to be viewed in conjunction with entry
into the EU. The latter is a formidable stimulus for
institutional change and modernisation. The prospect of EU
entry is driving the pace of change in these countries and
bringing in substantial capital. The target date of 2007 has
proved to be a catalyst for reform.
In the Western Balkans, the goal of NATO
membership is a powerful anchor of stability, helping to
defuse lingering interethnic animosities and disagreements
over national boundaries. Here too, however, the EU is
increasingly becoming an engine driving democratic change
and fostering economic progress. The Union is also a major
provider of economic assistance to the region.
NATO membership does matter greatly to the
economic development of Southeast Europe. In an
increasingly complex geopolitical environment, however,
joining the Alliance is not a catch-all solution. Moreover,
neither NATO nor EU membership should be regarded as a
substitute for astute and consistent local policymaking.
Ultimately, long-term economic progress and the ability to
176

meet the requirements for Euro-Atlantic integration

depends on the countries themselves. The energy driving
reform must come from within.
Setimes 26.07.2004

FIGHTING CORRUPTION IN SEE COUNTRIES:

THE EU FACTOR
Romania's expected entry into the EU in 2007 is proof
of the dramatic progress the country has made. But several
areas of concern still exist, with one of the most important
being the widespread problem of corruption. Polls repeatedly
show that corruption especially as it applies to the judicial
system is among the top frustrations and concerns of the
country's citizens. While optimists are confident in the ability
of structural and institutional reforms to reduce unethical
behavior, others point with alarm to the problems of "path
dependency" and traps of underdevelopment. The EU itself
could become the catalyst needed to force a breakthrough in
problem areas.
EU country reports underscore Romanias progress in
the quest to join the EU in 2007, but they also single out
corruption as a damaging social and economic phenomenon.
There is hardly a domestic poll that does not mention
corruption and the poor functioning of the judicial system as
one of the top frustrations and concerns among the country's
citizens. What, then, are the prospects for tackling these
problems?
Two trains of reasoning can be detected with respect to
explaining behavioral patterns during transition. Both can be
extrapolated to developing economies in general. The first,
177

more optimistic one emphasises the institutional weakness of

post-communist societies, the precarious functioning of
checks and balances, and a corrupted judiciary combined
with feeble law enforcement capacity. Ideally, the steady
advance of structural and institutional reforms would allow
transition societies to reduce unethical behavior considerably
over time. Both micro-inefficiencies and resource misallocation
would diminish and economic performance would gradually
improve. The rule of law would also become a reality.
One version of this hopeful line of reasoning points to
the strong performance of a series of emerging economies
especially in Southeast Asia that have had problems with
wide-ranging corruption and cronyism. These examples
suggest that corruption, on a massive scale, may be an
inescapable companion of the transition out of poverty, while
reducing it is a time-consuming affair.
Joining the EU can be seen through the lens of this
upbeat logic. Membership would, arguably, provide an
extraordinary anchor for systemic transformation and
economic progress. Accession would mean the "Big Push",
that the economist Paul Rosenstein Rodan mentioned more
then six decades ago in the British Economic Journal,
highlighting what Southeast Europe needs in order to defeat
the traps of underdevelopment. Indeed, Romanian citizens
are counting on EU accession to help deal decisively with the
countrys social and economic weaknesses, including
widespread "rent-seeking" and other forms of corruption.
The entry of eight transition countries into the Union on 1
May 2004 seems to substantiate this line of reasoning.
However, there is also a more pessimistic vein of
thought which stresses "path dependency" and points to the
persistence of widespread corruption, precarious institutions and
malfunctioning markets in large parts of the world. Latin
America offers a glaring example in this regard. What
178

explains the persistence of bad social equilibrium and poor

economic performance over long stretches of time? Why is it
that vicious circles and traps of underdevelopment are so
hard to break away from? Why has the economic rise of a
series of Asian countries been more the exception than the
rule in modern history, even though their advance has not
been devoid of corruption and cronyism?
The experience of Latin American countries provides a
cautionary tale for less advanced transition countries in
Southeast Europe and the former Soviet Union. In the
Balkans, for instance, weak state syndrome and the fragility
of institutions, as well as the large degree of criminality in
economic life should be a cause of deep concern for those
who hope to reverse an unfavorable path dependency. True,
the EU can provide an extremely powerful anchor and
transformation tool for the whole region, as it has done for
Central Europe. But there is little doubt that the process
could be made more time-consuming and painful because of
specific local conditions, including political and interethnic
conflicts.
Joining the EU will offer Romania an extraordinary
opportunity to improve its public policies and, consequently,
its economic performance; in addition, it will have the
chance to combat corruption more effectively. The "social
engineering" inherent in implementation of the acquis is
bound to change institutional structures (the judiciary
included) for the better. More transparency, more rule of law,
more clear rules of competition (and state aid) are part and
parcel of this process.
The change of government in November 2004 was
made possible by Romanians longing for truth and fairness,
but decisive progress has not yet been seen. The
ineffectiveness of the special bodies that were set up to deal
with corruption is notorious, while media reports have
179

exposed the unsavory links between politics and justice. To

put it bluntly, Romanian politics abounds with hypocrisy,
prevaricating rhetoric, arrogance and lack of accountability.
More than a few top notch officials are indifferent to
conflicts of interest; some nonchalantly use their office for the
pursuit of private gain. The fuss and procrastination surrounding
lawmakers' declarations of personal wealth was quite telling.
Again, one thinks ahead to EU entry as the event that is most
likely to trigger the needed change in mindset.
Certainly, the country needs better trained, more
responsible people at the very top people with a sense of
the urgency of the times and of the challenges facing
Romanias endeavour to join the EU under the best possible
premises. For EU accession, of course, will not shape
Romanias future in a predetermined manner. Much would
stay in the hands of Romanian policymakers, and much will
depend on responsible politicians pursuing intelligent and
effective public policies; policy ownership is far from being
a meaningless concept.
Romania's Western counterparts, whether in the state
or private sector, should do their part by being more candid
and by abiding by the same rules of transparency and ethical
behaviour which they encourage transition countries to
emulate. If, for instance, a Romanian policymaker
continually shuns the correct tender procedures for handling
public money, Western colleagues should not hesitate to
inform that person that such an approach is not acceptable.
While corruption is also found in affluent countries of
Western Europe and in the United States, in those societies
the rule of law is solid, and checks and balances operate
effectively in the end.
For this reason, the West should always use "best
practices" when they deal with Romanian officials or
companies. When raison d'tat impedes what is meant by
180

"best practice", this should be stated clearly, with

justification. In this way, Romanias progress toward
accession and what follows would be enhanced, for the
benefit of its citizens. Consequently, the propensity for
playing unethical games would be kept under control. After
15 years of transition, Romanian citizens deserve a better
functioning democracy and economy.
Setimes 6.06.2005

EU PRESIDENCY HOLDER AUSTRIA HAS

CLOSE TIES TO SEE COUNTRIES
At the start of 2006, Austria took over the six-month
presidency of the EU. Its task has been made easier by the
fact that Britain was able to settle the EU budget issue during
its mandate, although the budget must still be validated by
the European Parliament. The budget, covering years 20072013, allots substantial structural and cohesion funds to
Romania and Bulgaria. Croatia, too, can look forward to
considerable financial assistance as an accession country.
One of the key events expected to take place during the
Austrian presidency is the decision on when Bulgaria and
Romania will join the EU. That will come in May, when the
European Commission (EC) releases its report, after which
the European Council will make a formal determination
about whether to activate the "safeguard clause" delaying
entry by one year.
Along with the Netherlands and Sweden, among
others, Austria is part of the group of EU member states that
is opposed to major issues being decided by the bloc's
"heavyweights". We can expect to see this point of view
181

receive a higher profile during the coming months. Vienna

has also been critical of the larger member states for their
approach to the Maastricht rules, such as the Financial
Stability pact requirements imposed on smaller states are
softened when it comes to Berlin or Paris.
With regards to enlargement, Austria is among the EU
states where public opinion harbours reservations about
bringing new states into the Union, and its leaders have
called for taking into account "absorption capacity" before
stretching the boundaries further. Recently, the country's
justice minister indicated that it is in no hurry to ratify the
accession treaties of Bulgaria and Romania, and will wait to
do so until the EC report.
At the same time, however, Austria is close to
Southeast Europe geographically and has close historical,
political and economic ties to the region a fact that bodes
well for the EU prospects of Balkan states.
In January, Chancellor Wolfgang Schuessel insisted
that the commitments Brussels has made to the Balkan
countries must be respected. "The countries in the Balkans
have a clear European perspective. They belong to the
European context without any doubt." Schuessel told
Le Monde.
Austria is now the country with the largest volume of
investments in Romania, a status it gained when Erste Bank
won the race for the privatisation of the Romanian
Commercial Bank (BCR) the largest external acquisition
ever made by an Austrian company. Austrian capital is decisive
in the oil industry, especially in the wake of OMV's
acquisition of 51 per cent of Petrom, as well as in banking,
insurance and other industries.
In a sense, this economic presence ties Romania
closely to "Mittel Europa" (Central Europe). Austrian banks
have also made important inroads into Bulgaria, Croatia and
182

Serbia, signaling an overall strategy of economic expansion

in the region. Vienna's attitude towards Bucharest could be
influenced by the stake held by Austrian capital in the
Romanian economy.
Arguably, the advantageous inclusion of Romanian
companies into European industrial networks is key to the
country's steady development and its chances of catching up
economically. Such inclusion brings with it the transfer of
high technologies, rising productivity, the creation of new
jobs and higher incomes for Romanian citizens. This logic
should apply to other emerging economies from Southeast
Europe as well.
Vienna's economic and political interest in this region
goes back centuries. Some Western media have even been
making fanciful comments about the reconstruction, by
economic means, of the Austrian-Hungarian Empire. Such
talk is an exaggeration, of course. Nevertheless, the fact is
that Austrian companies are very active in the Balkans, just
as German companies have been active in Central Europe.
Dynamic areas of influence exist across the EU, and it is
reasonable to guess that Austria places a high value on
Southeast Europe's membership prospects.
From the point of view of the EU as a whole, the
accession of SEE countries has a number of important
implications. In the short term, it means substantial outlays
of financial assistance to help with the development of
infrastructure and the enhancement of economic progress. It
also sharpens anxieties over labour flow, a concern which
has helped fuel anti-enlargement sentiment in the older EU
member states and contributed to the defeat of the proposed
constitution.
Over the longer term, however, this problem should be
defused as countries improve their economic situation an
expected benefit of accession. With economies growing and
183

living standards on the rise, the new EU members will no

longer function as major suppliers of labour.
EU prospects are also vital to maintaining regional
stability, especially in the face of thorny issues such as the
status of Kosovo. Such issues will be considerably easier to
resolve if the countries involved see a clear path to EU
membership in the not too distant future. By contrast,
obstacles on the path increase the risk of countries turning
inward and becoming more vulnerable to nationalist myths.
The best way to discourage dwelling on the past is to offer a
promising future.
Setimes 27.02.2006

WHICH WAY AHEAD FOR THE WESTERN

BALKANS?
In general, recent developments in the Western
Balkans have prompted more than a few pundits to sound
alarm bells concerning the relative neglect of the region by
Brussels and the main European capitals. The last report of
the Amato Commission which is made up of top European
politicians sent a strongly worded message in this regard.
Several times lately the European Stability Initiative, an
NGO whose work is dedicated to the western Balkans, has
issued similar warnings.
Various factors are influencing the course of events in
the Western Balkans, some which move things in the right
direction, and others which keep the region in the grip of
serious traps whether political, economic or interethnic. In
184

the recent past, one could sense a more forceful march in the
right direction. The attraction of joining the EU, though a
distant goal, played a decisive role. Good economic signs
multiplied: inflation was coming down dramatically all over
the region and, more importantly, economic growth was
picking up strongly.
The referendum in Montenegro captured the attention
of many European chancelleries. Some hailed it, while others
were cautious. Would it help find a solution to the Kosovo
issue? Would it put other forces into motion that would
enhance the quest for EU accession in the region? These are
questions that automatically come to mind.
The banking sectors in the region were being cleaned
up and able, after a long time, to fund growth via investment
and consumption credits. Intra-regional trade started to grow,
as local politicians acknowledged that Chinese walls do not
make sense for their small economies. Domestic politics
strengthened the hand of democratic forces.
What about the situation now? Economic data, at least
on the surface, do not indicate a worsening of the overall
state of affairs. Economic growth has continued, apparently
unabated. During 2005, the rise in GDP was 5 per cent in the
Western Balkans, except in Macedonia (where it was 3.5 per
cent). Inflation has been in the single digits, at the very low
end of the range except in Serbia, where it stood at over 16
per cent in 2005. And the strengthening of banking sectors
has continued, owing to the enforcement of better prudential
regulations and the inroads made by Austrian, Greek and
Italian banks.
However, there are areas where the data looks less
bright, illustrating an eye-catching variety of circumstances.
Aid addiction has not diminished in BosniaHerzegovina (BiH), where the current account deficit totaled
almost a fourth of GDP, while FDI amounted to less than 4
185

per cent of GDP. In Kosovo, the current account deficit has

been even higher over 30 per cent of GDP last year.
Remittances are high in the province (over 14 per cent of
GDP). But as an economist would point out, they do not
cover the current account deficit; the latter needs stable
capital inflows in order to be sustainable.
Unemployment remains high in BiH, Kosovo and
Macedonia, although local economists and officials dispute
the numbers and cite the vibrant informal sector. What is not
in dispute, however, is the propensity among citizens
especially youth to migrate and seek work abroad, due to
the high wage differentials. Substantial economic fragility
exists in the region and inward FDI, though increasing in
recent years, is not yet a driving force for creating jobs and
underpinning stability. Can the current positive trends be
sustained unless they are backed by a strong capital
formation process? Probably not. Furthermore, domestic
investment hinges on the prospects for joining the EU in the
not too distant future.
Across the region, the message is the same: The only
game is EU accession. The rationale for this quest is
economic, political and geopolitical. At a time when
Montenegro has broken loose completely, when Kosovo's
status is heatedly debated, when the economic fragility of
BiH poses a continuing headache, the heavyweights of the
Union should pay more attention to the region.
According to some Western policymakers, the
Salzburg EU summit again pledged the Union's support for
the region, renewing the commitments made in Thessaloniki.
And yet it is not unfair to say that the support shown in
Salzburg was more tepid. Western politicians have had to
respond to the change of mood in their electorates. The

186

referenda in France and the Netherlands signaled considerable

anguish regarding immigration, globalisation and the fate of
the welfare state.
The irony is that the EU enlargement of 2004 has not
been, on the whole, a nuisance to the old EU member states;
the latter are running trade surpluses with the former
communist economies and have relocated factories there so
they can compete better in world markets. In addition,
whatever some say about the "Polish plumber", the fact is
that workers from Poland, Bulgaria, Romania and so on fill
important niches in western labour markets and help those
economies function better.
Still, it is hard to deny that fatigue exists in the West.
Several top-notch politicians are lame ducks, and not a few
governments are reluctant to undertake painful reforms. On
the other hand, it is important not to misread the themes of
public debate. In truth, it is not the last wave of enlargement
that has triggered the fatigue in the "Old EU". Rigid labour
markets, unreformed educational systems, underfunded
welfare systems, insufficient spending on R&D, and an
inability to come to grips with the reality of a global
economy are the real root of the problem.
Romania and Bulgaria will most likely join the Union
in 2007, in spite of critical reports from the European
Commission. This should embolden Paris, Berlin, London
and others to be more forthcoming when it comes to the
prospects for Western Balkan states. A substantially eased
visa regime, more assistance for boosting the capacity to
absorb EU funds, and more clearly formulated messages
would help greatly to this end. How Brussels approaches
these issues will prove a key test of EU statesmanship.
Setimes 17.07.2006

187

ECONOMIC, POLITICAL,
AND INSTITUTIONAL ADJUSTMENTS
NEEDED FOR COUNTRIES JOINING THE EU
Two countries in Southeast Europe Romania and
Bulgaria are expected to join the Union on 1 January 2007.
Another, Croatia, is likely to be put on a faster track. Despite
worries about the EU's commitment to the enlargement
process, the Balkan countries still appear to be moving closer
to their accession goals. Assuming that remains the case, it
will be up to regional governments to make the necessary
economic, institutional and political adjustments. Let us
consider, for instance, the implications for economic policy.
To begin with, it is important to distinguish between a
"functioning market economy" and one that has the capacity
to absorb shocks in a highly competitive environment, as is
the case with the Union. Moreover, economic competitiveness
must be understood in a profounder sense. Joining the
European club demands compliance with a set of rules that
dent traditional policy prerogatives. For instance, free capital
movement (liberalisation of the capital account) is a must in
the EU, whereas a premature opening is dangerous.
Likewise, new entrants are bound to enter the eurozone
sooner or later. An economy that is not competitive enough
would have a very hard time inside the single currency area.
It is imperative for countries joining the EU to have
key institutions and mechanisms in place: a financial
intermediation sector and an independent central bank, a
substantial private sector where property rights are clearly
defined and protected, a functioning judiciary and
enforceable laws. Being able to fight corruption and
organised crime effectively is also a prerequisite.
188

The economy needs to be stable. That means bringing

down inflation to a reasonable level in a consistent manner,
and maintaining low budget deficits while quasi-fiscal
deficits are under control. Premises for economic stability
are the operation of hard budget constraints and the spread of
good governance practices in both the public and the private
sectors. Low budget deficits imply coming to grips with the
ballooning pressure on the pension system.
Public utilities are an important area of concern. It is
unwise to privatise them blindly. As a matter of fact, there
are utilities which should stay in the public domain; what has
to be done in their case is to introduce good governance.
Those utilities which are turned over to private hands need to
be well-regulated, so that consumers are not abused by
excessive tariffs.
However, some cautionary remarks qualifying the
above observations are needed. The fact is that economic
policymaking always involves tradeoffs.
Low annual inflation, at rates of 2 per cent to 3 per
cent, is not easy to achieve in economies that are catching
up, where income per capita is 5 to 10 times lower than the
average EU figure (in PPP terms). In more rapidly growing
economies, demand pressures collide with disinflation. This
can also happen because prices of domestic services (nontradeables) go up unabatedly the so-called BalassaSamuelson effect. As in Central and Eastern Europe, the
Balkan economies have grown by more than 5 per cent on
average in recent years. It is fair to acknowledge, however,
that sustained growth asks for more fixed capital formation
and human capital investment.
The currently low budget deficits may be misleading
for two reasons. One is that they are likely to hide chronic
serious under-funding of essential public goods, such as
infrastructure, education and health care. Another reason is
189

that after entry in the EU the new members have to boost

public spending for the sake of complying with their
obligations under the acquis. Therefore, one may confront
situations where budget deficits get out of control.
Unless policymakers succeed in improving tax
collection and reforming the welfare state (including the
pension system) rising budget deficits can cripple overall
economic stability. Rising deficits with growing current
account deficits are not an anomaly in rapidly expanding
emerging economies. Actually, current account deficits are
increasing in most of Central and Eastern Europe because of
economic growth differentials, compared to the older
members of the EU, and surging bank credit extended to the
private sector.
Against the background of capital account liberalisation,
current account deficits that are not financed mainly by
inward direct investment bring significant risks. It is the size
of external deficits that complicates the task of policymakers
when they have to decide on what is a prudent budget policy.
This explains why the IMF has insisted that Bulgaria should
run a surplus budget current account deficits have gone
beyond 12 per cent of GDP lately and the currency board
does not permit a fluctuation of the exchange rate.
Here we return to the issue of competitiveness.
Because capital inflows can be quite substantial, or inflation
differentials fairly high, the exchange rate may become
excessively over-appreciated. This can erode competitiveness
and destroy jobs. The effect would be particularly bad in
economies that are plagued by very high unemployment, as
in the Western Balkans. Low wages are not a panacea when
Chinese and other Asian goods flood European markets. To a
large extent, globalisation annuls the competitive advantage
of low wages in Europe. The transfer of new information and
communication technologies, combined with heavy
190

investment in human capital buildup, are a must for securing

long-term competitiveness.
Last but not least, massive migration can bring about
important benefits, but it can also be a nuisance. Large
remittances (to the tune of billions of euros for Romania and
Bulgaria) can finance between 25 per cent and 40 per cent of
trade deficits. But they imply the loss of highly skilled labour
and, in numerous cases, disruption of family life. This said,
for economies that suffer from huge unemployment, such
as those in the Western Balkans, labour export is positive in
net terms.
The bottom line is that policymakers in the Western
Balkans must look beyond the economic numbers of recent
years, understand the deep currents at work, be pragmatic,
and learn from the experiences of current EU members, both
old and new.
Setimes 14.08.2006

191

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